Today we have great flexibility with how we use our pension savings in retirement. But this increased flexibility also means there’s more to think about before making one of the biggest financial decisions of your life. Alistair McQueen, Aviva’s Head of Savings and Retirement, explains why.
Since 2015, new rules have greatly increased the ways you can take money from defined contribution pensions (that’s where you’ve built up a pot from your own contributions and maybe your employer’s too). In simple terms, from age 55 (age 57 from 2028) you can: withdraw all your money; withdraw some of your money as you want; use your savings to secure a guaranteed income for the rest of your life; or choose a combination of these options.
Here we focus on flexible withdrawals, which have proven very popular with pension savers. Since 2015, more than £59 billion has been withdrawn this way by more than two billion people.
There are basically two ways to take flexible withdrawals from your pension. Each option allows you to change the size of withdrawals over time.
- Flexi-access drawdown: You can withdraw up to 25% of your pension fund without paying any tax. Subsequent withdrawals from your remaining fund, for example, to set up a regular income, will be treated as income and taxed accordingly.
- Uncrystallised funds pension lump sum: This technical sounding option also goes by the acronym UFPLS, pronounced ‘uffplus’. Here each withdrawal is treated separately for tax purposes with 25% tax-free and the other 75% treated as income and taxed appropriately.
Once you’ve started taking flexible withdrawals, you could potentially need your fund to last for another 30 years or more. That’s a long time, so here are seven factors you need to consider:
1. Your pension’s rules
Not all pension products offer all the new ‘pension freedoms’. So, before making too many plans, check your own options with your pension provider. If your product doesn’t offer all the choices, you could transfer your savings to another pension that does. Approach this with care, though, as your existing product may have other valuable benefits that you would lose by transferring and you may not be able to transfer back. You should also consider the different investment options and charges of each product.
2. Life expectancy
A pension fund is typically designed to provide an income for the rest of your life. How long you’ll be retired is therefore very important, but obviously can’t be exactly predicted. You can, however, estimate your life expectancy based on typical experiences of others, helping ensure you don’t spend your pension fund too quickly and run out of money.
3. Consider all your pensions
You may have had a few different jobs with different employers, each with a pension. Before accessing any of these, it’s sensible to consider all your pensions in the round. By looking at your total pension savings you’ll be better placed to consider your options. You could also bring all or some of your pensions together in one pot, but there’s a lot you should think about before doing this.
4. Your investments
Your money will remain invested, and those investments could go down in value as well as up. You’ll need to be confident that your pension is invested appropriately and in a way that fits with your approach to risk. The fund value will depend on how much you take out, how your investments perform, and the charges taken, so future income isn’t guaranteed and you could get back less than has been paid in. Depending on the level of withdrawals, your money could run out.
Working or retired, one thing that continues is the taxing of your income, including pension withdrawals. And the size of flexible withdrawals can affect the level of income tax you pay. For example, a large withdrawal could move you into a higher tax bracket, so plan your withdrawals carefully. (If you’re still saving, taking a flexible withdrawal from a pension also reduces the amount you can pay into all defined contribution pensions each year without paying an additional tax charge from £60,000 to £10,000. Tax rules are subject to change and individual circumstances.)
6. Your State Pension
Before withdrawing money from any private pensions, you should check what you could get from the State Pension and when you can get it. You can do this on the government’s website.
7. Have you got a defined benefit pension?
Flexible withdrawals are not available on defined benefit (final salary) pensions. You’d need to transfer to a pension that does offer the option, but this is a significant decision to make. Large amounts of money may be at stake and the benefits of a final salary pension will be hard to replicate, such as a typically generous guaranteed income for life. You should get professional financial advice before going down this route.
Pension freedoms and the ability to take flexible withdrawals from your savings have been broadly welcomed. But wider choice also means increased responsibility. You need to take time to consider your options before you make a decision. After all, you may have saved for 40 years and you could even be retired for 40 years, so don’t feel pressured to act in 40 minutes!