How to steer your pension back on course
First published 23 May 2016 • Updated 25 July 2017
From the age of 55 you now have full control of your pension. But has anyone told you how to drive it? Taking wrong turnings now could limit your options later on – so make sure you arrive safely in your chosen retirement by taking our quick pension driving course.
Pensions are sometimes called ‘investment vehicles’. But if your pension were actually a vehicle, it would be like one of those container ships that takes a mile to stop, or a huge truck that needs a lay-by in which to turn around. Pensions are slow to steer – so if yours isn’t heading in the best direction, you need a make a special effort to nudge it onto the right course. And you should do it sooner rather than later.
Here’s why taking control of your pension is so important.
Pensions ‘on autopilot’
In days gone by, the only retirement option for most people was to buy an annuity – a guaranteed income for life – so most pension funds were designed with that in mind. Your contributions were invested in high-growth assets for most of your life, then moved into more stable assets shortly before your retirement age. This was done to maximise the size of your pot at the point when you’d need to spend it. Essentially, your pension fund was on autopilot, destination: annuity.
All this changed in April 2015 when pension freedom arrived. You can now access your pension pot from the age of 55, choosing how you want to take the money. In addition to taking 25 per cent of your pot tax-free, you can now choose from the following options:
- An annuity (a guaranteed income for life)
- A lump sum (or series of lump sums)
- Drawdown (re-investing your pension in a special income-generating portfolio and withdrawing money as needed)
Of these, drawdown has so far proved the most popular alternative to annuities. However, there’s a problem that many people fail to spot. Unless you’ve already taken action to sort this out, it is likely that your pension fund is set up with an annuity in mind. You are therefore unlikely to achieve the best value if you wish to use it for drawdown.
Similarly, some may wish to take their pension as a series of lump sums. Superficially this looks similar to drawdown – but there is one important difference. In this scenario, your pension pot is not being actively managed to generate an income, as it would be with drawdown. It is therefore likely to decrease in value more quickly over time. This is another example of the ‘convenient’ option not usually being the best.
Your pension – learning how to drive it
As mentioned already, pensions are slow, cumbersome vehicles that can take some time to steer. Arriving in your chosen destination in a few years’ time means taking the right action now. This means deciding how to draw your pension well in advance – preferably five, ten or even fifteen years before you start to do so.
You can of course delay your decision until you begin draw your pension – but this is far from ideal. By leaving your pension in the provider’s default fund all that time, you are potentially missing out on the chance to boost your savings in the run-up to retirement. This in turn may make drawdown a less attractive option, and steer you more in the direction of an annuity – even if you didn’t initially want to do it that way. By failing to plan far enough in advance, you run the risk of letting your pension fund steer your decision, rather than the other way around.
Planning five or ten years in advance gives you a destination to aim for. You can then see if your pension is currently on course for that destination – in the vast majority of cases, it will need at least some fine-tuning, and sometimes some major manoeuvring to ensure it is heading in the right direction.
Here are the steps you should be taking to keep your pension on track.
Mirror, signal, manoeuvre
- Get a sense of where you are now
Then get a projection of the total value of your pensions at retirement. One way to do this is to book a free pension check with an independent adviser.
- Check your blind spots
Usually it’s a good idea to consolidate all your pension pots into one, both to save on fees and to maximise the size of the best-performing fund. However, there are reasons not to do this with some pensions. Some defined contribution pensions have guaranteed annuity rates which can be very valuable, and defined benefit pensions provide a guaranteed income which is generally worth keeping. Talk to your adviser about which pensions you should or should not consolidate.
- Think carefully about your retirement plans
Start making concrete plans about how (and where) you’re going to spend your retirement. It can help to break your retirement down into stages, or even five-year chunks. This way you can see how your likely spending patterns may fluctuate over time. Also consider other sources of income during this period of your life. Our Retirement Countdown checklist can be a great help here.
- Discuss pension choices with your financial adviser – in advance!
Pension freedom is relative new, so its first users did not have much chance to prepare for it. But if you are still some years off retirement, you have an advantage. Talk to your financial adviser about your retirement plans and ask them to explore with you the different pension options. You can then get a good idea of different scenarios and what kind of income you might expect in each one. If you identify any problems or risks at this stage, you then have time to take remedial action.
- Ask your adviser about any action you should take
If your pensions are not currently in line with your plans, ask your adviser how to rectify this. For instance, if you are very likely to choose drawdown over an annuity, then ensure that your pension fund is arranged with this in mind. It’s also good to know if you need to increase your contributions at this stage.
- Finally, shop around for the most suitable, best-value products
This is another area where independent advice can help. Your adviser can weigh up all your circumstances and search the whole of the market to find the product that fits your needs best. This assessment takes into account all your other financial circumstances too, and factors in your attitude to risk. It’s therefore the most effective way to make a fully informed decision.
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