Whether you're planning to retire fully, or gradually, you now have more choice and flexibility in how you provide you and your family with an income in retirement.
Many of us are living longer so the chances are you will be retired a long time. It’s therefore important to make sure you have enough secure income so you’re not worrying about how to pay the bills.
Security & flexibility
Retirement can last for 30 years or more depending on when you retire and how long you live.
Estimating how long your retirement will be is difficult as few of us know how long we're going to live. You need to bear this in mind when deciding what to do with your retirement savings – they may have to last longer than you think.
You may also want to make provisions for any family or dependants you have so that they receive an income and/or inherit any unused money from your pension pot when you die.
Once you’re 55 you have complete freedom over how you use your pension pot. But you still need to ensure you have enough secure income throughout the whole of your retirement so that you can make ends meet.
A good place to start is by working out what income you’ve got and how much you’ll need.
What have you got?
Most people have more than one source of income in retirement.
Secure income
This is any income that is regular and guaranteed for life such as:
- your State Pension
- a pension from a defined benefit scheme (also known as an employer’s salary-related pension scheme such as a final salary or career average scheme)
- income from a lifetime annuity
Flexible income
This is income you hope to get but the amount might vary and it’s not guaranteed to last for the whole of your retirement. This includes income from:
- paid work
- a drawdown scheme (where your pension pot remains invested but you can opt to draw an income from it)
- savings and investments
- renting out a room in your home
- any rental property you own.
What else will you have?
You may have non-pension assets which could affect what you decide to do with your pension pot. These might include:
- your home – you may plan to sell your home and buy a cheaper one in order to release some cash
- other property which you could sell or rent out
- savings and investments
- personal possessions you plan to sell such as a car, jewellery, antiques etc.
If you have any outstanding loans, a mortgage or credit card debts, paying these off may seem a good idea. This would reduce your monthly spending and the amount of income you need in retirement. But it would also reduce the amount of money you have available to provide yourself with an income in retirement. This is the sort of decision that requires careful thought and which you may want to take advice on.
How much will you need?
It’s not just your income that’s likely to change in retirement, your spending will too. For example, you may no longer have to pay fares to get to work but if you spend more time at home your household bills may increase.
If you draw up a budget of how much you’re likely to spend when you retire you will have a clearer picture of how much income you need and this could help you decide what to do with your pension pot.
The basics
You'll need a secure source of income to pay for life's basics such as food, bills and clothing.
Independence & flexibility
With your basics covered, it's safe to invest your money in things like a car, savings or home improvements.
Life's little luxuries
With your living expenses covered, luxuries such as a daily cappuccino, gifts or holidays are within reach.
Tax
Your pension income is taxable just like any other income.
When you’re ready to start using your pension pot, you can usually take up to 25% of it as a tax-free lump sum. The rest can be used to provide you with an income and/or irregular lump sums, both of which are taxable. The amount of Income Tax you have to pay depends on your total income for the year.
Alternatively, you can take cash lump sums from your pension pot. The first 25% of any lump sum is usually tax-free and the rest is taxable. The taxable amount is added to the rest of your income for the year and you pay Income Tax on this in the usual way.
In both cases, if the amount of taxable cash you take pushes your annual income into a higher tax bracket, you’ll have to pay higher-rate tax (or even additional-rate tax) on the part of your income that falls in that band.
Income Tax rates 2018-2019: England, Wales & Northern Ireland
| Income Tax band |
Your income |
Income Tax rate |
|
Your personal allowance
1
Definition of Your Personal Allowance
|
Up to £11,850 |
0% |
| Basic rate |
£11,851 - £46,350 |
20% |
| Higher rate |
£46,351 - £150,000 |
40% |
| Additional rate |
Over £150,000 |
45% |
Income Tax rates 2018-2019: Scotland
| Income Tax band |
Your income |
Income Tax rate |
|
Your personal allowance
1
|
Up to £11,850 |
0% |
| Starter rate |
£11,851 - £13,850 |
19% |
| Basic rate |
£13,851 - £24,000 |
20% |
| Intermediate rate |
£24,001 - £43,430 |
21% |
| Higher rate |
£43,431 - £150,000 |
41% |
| Additional rate |
Over £150,000 |
46% |
1
The personal allowance is the amount of income you can have before you have to start paying Income Tax. When your income is over £100,000, your personal allowance reduces by £1 for every £2 above the limit.
Working out when and how much cash to take from your pension pot so that you don’t end up paying more tax than you need to can be complicated and you may want to take financial advice on this.
Annual allowances
The maximum amount you (and your employer) can contribute to your pension each year and receive tax relief on is £40,000 (or the amount you earn if that’s less). The £40,000 annual allowance will be reduced if you have an income of over £150,000, including pension contributions. If you’re not earning, you can still get tax relief on contributions up to £3,600. Any contributions above this you pay Income Tax on.
Tax relief on future pension savings
If you start using your pension pot (you may want to take some cash or a flexible income), the maximum pension contributions you can then get tax relief on falls to £4,000 (or the amount of your earnings if that’s less). This is called your money purchase annual allowance (MPAA).
Lifetime allowance
The maximum pension savings you can build up without incurring a tax charge when you draw out your savings (and without leaving a tax charge for your beneficiaries if you die before age 75) is £1,030,000. If your pension pot is worth more than this, you’ll pay tax (25% on income and 55% on cash lump sums) when you withdraw the excess amount.
Health and longevity
People are living longer than they used to. A 65 year old man now has a 50% chance of living to 87 and a 65 year old woman has a 50% chance of living to 90.
Many people underestimate how long they’re going to live. This is not a problem if you have a guaranteed income for life. But if you don’t, you need to make sure you don’t run out of money so that you have enough to live on for the whole of your retirement. At the same time, you don’t want to live more frugally than you actually need to because you’re worrying too much about running out of money.
Your health may become an issue as you get older. So you may want to set aside some money or have a rising income so that if your health does deteriorate you can afford to pay for extra help around the home or for care fees.
Inflation and risk
Prices tend to rise over time. If your retirement income does not keep up with rising prices (inflation) then you may struggle to make ends meet as you get older.
To maintain your standard of living, you need your income to keep up with inflation. You may do this by buying an insurance policy that gives you a guaranteed income for life (a lifetime annuity) that changes with inflation each year.
Your State Pension will keep up with inflation as it rises by at least this amount each year.
If you’re relying on savings and investments to provide you with an inflation-proof income then the amount of interest or income they earn needs to keep up with inflation too.
If you don’t use your pension pot to secure yourself a guaranteed income in retirement but instead leave your pot invested, you need to decide how much risk you’re comfortable taking with your money. If your investments fall in value so will the value of your pension pot. On the other hand, your investments could increase in value and this means you would have a bigger pension pot.
Inheritance
You may want to leave some or all of your pension savings and/or the income from these to your dependants when you die. This may affect the retirement income options you are considering and may mean you have to accept a lower income in retirement.
Your choices may also be influenced by the way that any pension savings or income you leave your dependants is taxed.
Whether you opt for an annuity, drawdown or leave money in your pension pot, it’s essential you complete an expression of wish form to say who should inherit any cash or income due from this. If you don’t, your retirement product provider may not know who should inherit this and your heirs may have to pay unnecessary Inheritance Tax.
When you die, whoever is dealing with your estate must notify your pension provider of your death.
What happens to your pension pot when you die
| Money inherited from your pension pot |
If you die before age 75 |
If you die aged 75 or older |
| Lump sums |
Any lump sum claimed within two years is paid tax free 2See exceptions |
Any lump sum paid to your beneficiary is added to the rest of their income for the year and taxed at their appropriate tax rate. |
| Income |
Any income claimed within two years is paid tax free 2See exceptions |
Any income paid to your beneficiary is added to the rest of their income and taxed at their appropriate tax rate. |
2 Any lump sum or income claimed more than 2 years after notification will be added to the beneficiary’s income and taxed at their appropriate rate.
