Updated 25 July 2017
We’re a year into pension freedom, and the UK is starting to get a feel for the new way in which pensions work. If you plan to take your pension within the next five to ten years, make your choices easier with these tips and rules of thumb.
If you’re planning to retire in the next couple of years – or to start drawing your pension so you can cut your working hours – then you’re probably aware that there are choices to be made. Retirement planning is a complex area and there’s a huge amount to think about, so we’ve broken down the key points into a set of eight simple tips. It’s not a definitive how-to guide but it should really help to get you started.
Knowing what you’re doing is half the battle. Before you consider any options, read up on pensions – what they are, how they work, and how they’ve changed since 2015. This quick guide is a great place to start, giving you a simple introduction to the main options for taking your pension.
Unless you’ve worked for the same employer your whole life, the chances are you’ll have numerous pensions of various sizes dotted all over the place like lost sheep. Before you make retirement plans, it’s usually good practice to herd all these little pots together into one flock. Getting a financial adviser to do this can save a lot of time and hassle – and they’ll also be able to tell you if any of those pension are best left alone (see points 3 and 4 below).
Some pension schemes include a guaranteed annuity rate (GAR). This can be a hugely valuable asset, and may be a good reason not to cash in or move that particular pension pot. A GAR entitles you to buy an annuity at a pre-fixed rate, so potentially it could pay you much more in retirement than any annuities currently on the market. Find out more about GARs here.
A defined benefit (DB, aka final salary) pension isn’t a pot of money, but an arrangement that pays you a guaranteed income for life (rather like an annuity). It is possible to trade in such a pension for a pot of money, but in many cases there are strong arguments for keeping such pensions even if they are quite small. You should consult a financial adviser about whether or not to transfer a DB pension (if the transfer value is £30,000 or over then seeking advice is required by law).
The advantage of trading in a DB is having a single pot of money you can access flexibly. However, many people don’t seem to be thinking this through. A study by Willis Towers Watson of 15,700 DB pension holders found that 36 per cent chose to transfer out – and that nearly half of these (45 per cent) went on to buy an annuity. In most cases this would be a baffling decision, since the annuities purchased would in most cases be no better than the original DB pension, and could well be inferior to it.
They call it ‘pension freedom’ but there is one big ball-and-chain that could still trip you up – and that’s tax. You can take 25 per cent of every pension pot tax-free, but after that, income taken from a pension is taxed exactly the same as any other income. You need to take all your income into account (including your state pension) when working out your tax bill, so it can get quite complicated. As a rule of thumb, remember that big single withdrawals are likely to trigger much larger tax bills.
With good health, a typical retirement may last 25 years or even longer. You should therefore consider how your lifestyle and needs will change over that time. For example, your earlier retirement years are likely to be much more active, but in later years you may need to fund long-term care. A financial adviser can provide invaluable help here, by building a cash-flow model and detailed financial plan, so you can map your retirement finances in advance.
Despite all the enthusiasm for pension freedom, many people have gone too far in the other direction. A sizeable percentage seem reluctant to use even the choices they had pre-freedom. Research by the Associate of British Insurers (ABI) showed that 60 per cent of those who bought an annuity took the one offered by their existing pension provider. This inertia can be very costly: over 20 years, the best standard annuity rate will pay over £4,000 more than the average currently available. You may also find that you qualify for an enhanced annuity, which can be much more valuable.
Similarly, if you are opting for a drawdown scheme, remember that these vary considerably from provider to provider, so you need one that suits both your requirements and your attitude to risk. A financial adviser can look at your circumstances in detail and find the product that fits you best.
Pension freedom has given us all much more choice in how we plan our retirement – but also much more scope for making poor decisions. Of all the times of life when it’s good to seek financial advice, your retirement is probably the most important moment of all, as you may have only one chance to get it right.
Find your financial adviser today at unbiased.co.uk. Use the search filters to find one who specialises in pensions and retirement.