Pension options: What should I do with my pension pot at retirement?

Before you retire, it’s a good idea to understand your pension options, as this will likely be the main source of your income during retirement. 

By now, you should have built up one or more workplace or personal pensions, which you can usually access from the age of 55. The age you can access your pension is rising to 57 from 6 April 2028. 

How you access your pension will require careful planning as this money needs to last you for your retirement. 

Here are your main options for drawing your pension, along with the key issues to think about. 

Before we jump in, this guide focuses mainly on defined contribution pensions as a defined benefit (DB) pension works differently. 

When can I take my pension?

If you have a defined contribution pension, then you can legally access the money from the age of 55 (rising to 57 in 2028).

But that doesn’t always mean that you should.

Your pension has to support you through retirement, so ideally you should wait as long as you can before accessing it.

Some advisers recommend spending other savings before withdrawing from any pensions, as these are not subject to inheritance tax, whereas savings and other assets are.

You don’t need to be retired to access your pension – you can continue to work full-time if you wish.

However, your pension income is subject to tax, so if you’re still working, then your tax bill will be higher.

What if I decide to postpone my retirement?

You don’t have to start drawing from your pension when you’re legally allowed to.

Instead, you can leave your pension invested until you need to access it.

If you do this, it’s worth checking if your pension provider is using ‘lifestyling,’ an investment strategy where your pension fund is automatically switched to a lower risk one as you approach retirement.

Lifestyling may mean your investments grow at a lower rate as more is invested in assets like bonds and cash that are typically lower risk.

While you can claim your state pension when you reach state pension age, you can defer it. There are some financial benefits, as you’ll get paid an extra amount with your usual payment when you claim it.

If you reach state pension age on or after 6 April 2016 and delay claiming, your state pension will rise by 1% for every nine weeks you defer or around 5.8% if you delay for a year.

Alternatively, for those who reached state pension age before 6 April 2016, their state pension rose by 1% for every five weeks they delayed claiming or 10.4% if they deferred for a year.

Will my pension affect my benefits?

As some benefits are based on how much income you have, as well as savings and investments, you may become ineligible for some benefits if you access your pension.

It also depends on whether you are at least state pension age, as you can claim pension credit.

If you can get pension credit, money from your pension you would be entitled to, and any funds you take out will be taken into account when working out your income.

But if you’re not claiming pension credit, only funds you withdraw from your pension are considered as income.

How to avoid pension scams

You’ve worked your whole life to build up your pension, so it’s vital you protect it from scammers.

There are many ways scammers try and get hold of your money, including offering fake investments with unrealistically high returns.

It’s worth being wary of any red flags such as unsolicited contact, especially as there has been a ban on cold calling about pensions since 2019.

Scammers will try and rush you to make a decision, often claiming it’s a limited time offer.

They may also try and tempt you with a free pension review or to offer to help you access a pension before you turn 55, the latter of which is usually not possible.

Scammers may also imitate genuine firms, who would never contact you without your permission.

What are your main pension options?

You have several options for accessing your pension. 

Each option has its own pros and cons, and some can be used in combination with others. 

• A 25% tax-free lump sum
• An annuity
• Drawdown
• Taxable lump sums 

Can you take a pension lump sum tax-free?

You can take up to 25% of any pension pot tax-free. The simplest way to do this is through a single lump sum.

This can be an attractive option if you want a larger sum to spend early on in your retirement, such as for travelling.

However, you still need to keep a level head and ask yourself how much you can afford to spend.

Remember, you don’t need to spend it at all, and it may be prudent to reinvest some or even all of it as a source of extra funds to draw upon when needed.

This may be a particularly useful strategy if you are using drawdown, as there may be times when it’s sensible to reduce your drawdown income temporarily.

How do I access the rest of my pension pot?

Once you have taken your tax-free lump sum, any further money you take from your pensions is taxable and will attract income tax, although you don’t have to pay national insurance on pension income.

You have a range of options for taking this income.

These are:

• Buy an annuity (a guaranteed income for life)
• Set up a drawdown scheme (to give you flexible access to the rest of your pot)
• Take out one or more taxable lump sums
• A combination of these

We will now delve into each of these pension options in more detail.

How to buy an annuity

You can exchange some or all of your pension pot for an annuity. 

An annuity is a type of insurance product, which will pay you a guaranteed income for the rest of your life – or for a set period of time. 

However, the downside is that you can’t vary the amount you receive after you have set it up, and it could be many years before you get back as much as you paid for an annuity.  

You can arrange for your annuity to pay an increasing amount each year, to combat inflation although this will cost you more initially. 

You can also buy a joint annuity that covers your spouse as well, which will continue to pay out a reduced amount after your death, for as long as they live – but this will cost you more. 

If you have a health condition, you may qualify for a more valuable enhanced annuity. 

Find out more about the pros and cons of an annuity.

How to set up a drawdown scheme

You can have some or all of your pension pot reinvested into a drawdown scheme.

The main advantage is flexibility, as you can draw out as much or as little as you wish each year, with the money being taxed as ordinary income.

However, a key downside is your pension pot will shrink over time, and you may run out of money. Your funds also remain exposed to the stock market, so they can fall in value as well as grow and can significantly shorten the life of your pot.

If you take money out when the market is falling, it is harder for the rest of your pot to recover later.

This is why it may be worth keeping some of your tax-free lump sum as an emergency reserve in case the stock market struggles, as it allows you to reduce your drawdown income and minimise the impact on your pension pot. 

Find out more about the pros and cons of drawdown.

A taxable lump sum

It’s possible to draw the whole of your remaining pension pot (after taking a 25% tax-free lump sum).

However, the remaining 75% will be taxed as ordinary income. For larger pots, this can result in losing a big chunk of your money due to a hefty tax bill.

If you have a small pension pot you don’t want to combine into your main pension, taking the whole thing as a lump sum may be a practical solution.

It’s worth talking to a financial adviser to see what they recommend.

Taking your tax-free lump sum gradually

If you haven’t yet taken your tax-free lump you have another option known as an uncrystallised funds pension lump sum (UFPLS).

This allows you to take a series of lump sums from your pension without moving your pension pot into a drawdown. 25% of each withdrawal will be tax-free, and the remaining 75% will be taxed as pension income.

This option is extremely flexible and might be attractive if you haven’t yet decided how to access your pension.

A combination of methods

You don’t have to choose one option or the other exclusively. If you wish, you can set up various strategies for taking income from your pension pots to provide flexibility and security.

For example, you could set up a drawdown scheme to meet your needs in the first part of your retirement. When you are older and less active, you could use the remainder of your pot to buy an annuity.

As you’ll be older, you may be able to buy an annuity at a higher rate. Alternatively, you could set up a small annuity to cover your basic needs and take extra income from drawdown as necessary.

How does drawing a final salary pension work?

A final salary pension (also known as a defined benefit pension) is a type of workplace pension that works in a different way.

Instead of building up a pension pot, it pays you a guaranteed income from a certain age (a bit like an annuity).

Some will also enable you to take a tax-free lump sum as well.

You don’t have to do anything to draw this kind of pension, as it will be paid to you automatically from the date specified by the scheme.

This is called your ‘normal retirement date’ and is usually set around 60 (but may be earlier or later).

Some final salary pensions will allow you to transfer out of them, exchanging your guaranteed pension benefits for a pension pot of a certain value.

There can be advantages to doing this, but there are also significant risks, so you should speak to a financial adviser if you want to consider this option.

How does inheriting a pension work?

If you have a defined contribution pension, you may have unused pension wealth remaining to pass on to your loved ones.

There is currently no inheritance tax (IHT) to pay on inherited pensions, but the rules are changing. From April 2027, pensions will be subject to IHT and may be charged at 40%, depending on your other wealth and allowances available.

Pensions left to your spouse or civil partner won’t attract inheritance tax, as assets left to spouses are exempt from IHT. 

When it comes to withdrawing income from an inherited pension, the rules are different depending on your age when you die.

If you die before the age of 75, your beneficiaries can receive any remaining pension pot as a lump sum without paying income tax, but the amount is capped under the lump sum death benefit allowance (LSDBA).

If you pass away after age 75, the remaining pot will be taxed at your beneficiaries’ marginal rate.

These tax rules can be a crucial consideration in your retirement planning, as it impacts how you might choose to manage your pension funds.

What should you do with your pension pot?

The pension choices you make should be based on your own personal circumstances and goals.

It’s a good idea to talk with a financial adviser, as they will help recommend the best course of action.

Your pension strategy may change during your retirement, to reflect your adjusting needs and lifestyle. So, any advice can ensure your retirement is properly tailored to suit your needs.

If you are hoping to access your pension from the age of 55, see our article on retiring early.

You can estimate how much annual income to expect in retirement using Unbiased’s pension calculator.

Get expert financial advice

Navigating your pension options requires careful consideration of your individual needs and retirement goals.

Whether you take a tax-free lump sum, set up an annuity, or opt for drawdown, each choice has its benefits and implications.

Be mindful of how these decisions impact your long-term financial stability and potential tax liabilities.

Let Unbiased quickly match you with a financial adviser for expert financial advice so you can make informed choices to help secure a comfortable and financially stable retirement.