Handling your pension can sometimes feel like a high-wire act. With so many options to consider, and all the usual hopes and concerns about how far your money might go, identifying the right strategy can often feel overwhelming.
In this blog, we’ll dive into the different options for making your pension work for you, so you can enter retirement feeling confident about your income — and empowered in your spending.
Pension options for retirement
Once the retirement cake has been eaten and the decorations put away, the first task of your post-employment life will be to decide how you want to receive your pension.
Typically, this process begins with your pension provider(s) reaching out to you to detail the different ways you can receive your retirement money:
Taking all your pension as a lump sum
One way to receive your pension is to take all the money in your pot as a single lump sum.
In simple terms, your pension pot refers to all the savings you, and – if you’re employed – your employer, have accumulated throughout your working life. This money may consist of your workplace pension, a private pension, or (if you have them) both.
However, this pot is separate from the State Pension (a pension paid regularly by the government), or a ‘final salary’ pension (a different kind of pension where you’re paid an annual wage based on your final salary, rather than accrued savings).
When you withdraw your whole pension as a lump sum, the first 25% is tax free – while the remaining money (75%) will be taxed as earnings. Practically, this means that, after tax, all of your pension pot is accessible straight away.
This option could give you more freedom, as you can use the money however suits you (and you’re not committed to your pension scheme’s investment strategy).
For many people, the early years of retirement can come with more expenditure than the later years. After all, you’re now free to use your time as you’d like!
With a lump sum, you can weight your retirement spending towards this more active period.
Still, receiving a lump sum is not for everyone.
It goes without saying that your pension should provide you with financial support throughout retirement. If you overspend early on, this could put your future financial security at risk.
Once you’ve received your lump sum, you’ll then also need to hold your money somewhere – say, in a savings account – which could mean that the value of your money decreases in real terms.
Taking several lump sums
A single lump sum isn’t your only option. You can also decide to access you pension pot by taking out several lump sums over the course of your retirement.
It’s important to note that every time you take out a lump sum, your money will be subject to the same tax treatment. That is, the first 25% tax-free, with the basic-rate income tax deducted from the remaining 75%. This tax treatment applies every time you withdraw a lump sum, while any money still in your pot remains invested.
Taking smaller lump sums over time can help you manage your income, while your remaining pension fund still has the potential to grow. However, there are no guarantees; the value of your pension pot can fall as well as rise.
Keep in mind, too, that not all providers offer this option, and some may limit how much you can take out. Sometimes lump sums are also subject to fees, so it’s worth checking your policy if this is an option you’d like to explore.
Pension annuity
For some, lump sums can seem less empowering and more worry-inducing. After all, it places the onus on you to ensure your pension lasts your whole retirement.
Luckily, there are alternatives — including purchasing an annuity.
A pension annuity is a type of insurance or ‘product’ purchased with the money available in your pension pot.
Based on factors such as your life expectancy and the amount you have saved, an annuity provider will give you a quote for an annual payment that they guarantee to pay you for the rest of your life. In this sense, it’s a bit like a salary.
Some people entering retirement will consider this option as they don’t have to worry about dwindling money in later years. It also means they can set budgets with a clear picture of what amount they will receive, and when.
On the other hand, opting for an annuity could mean that you don’t capitalise on the full value of your pension pot. The majority of pension annuities are not linked to investments, meaning there’s no chance for your money to grow.
It’s important to note, too, that annuities are not reversible; once you’ve entered into one, you’re committed for the rest of your life.
Pension drawdown
Lastly, you can also receive your retirement money via pension drawdown.
Similar to taking several lump sums, a pension drawdown allows you to take money from your pension at different times.
However, unlike lump sums, a drawdown means your pension stays invested while you take a flexible income sourced from a drawdown pot. Your pension can be moved into a drawdown in one go, or you could opt to stagger the movements over time.
You can usually take 25% of the total amount in tax-free cash up front. The rest of your money then remains invested, and you’ll have the option to decide how much income (subject to tax) to take after that. You can either opt into a drawdown with your pension provider, or – if they don’t offer it – transfer your pension to a different provider.
Always consider which provider best suits your needs, especially when switching, to ensure you won’t be subject to any fees — or in danger of losing potential benefits with your current provider.
For more information on the rules of a pension drawdown, please read our handy article.
Combine pension options
If you’re still scratching your head and looking through the choices above, you could always opt to combine a few of the options we’ve detailed.
For example, you could portion off a part of your total pension to purchase an annuity, and still opt to receive money through one (or multiple) of the other options with the amount remaining in your pot.
Taking your pension in this way can give you peace of mind, without limiting your freedom to weather varying spending periods throughout your retirement.
How to manage your pension pot
In this final section, we’ll look at what strategies you can use to get the most out of your pension — however you decide to receive it.
The 4% rule
A popular budgeting strategy that many people adopt in their retirement is the 4% rule. This simple approach involves withdrawing 4% of your total pension fund in the first year of your retirement, and is often seen as a way to help maintain the health of your pension pot over time.
For each new year, you simply take another 4% from your pension pot (adjusting for inflation), and – in theory – your money should last for the rest of your retirement.
However, some experts have pointed out that this rule is based on certain assumptions, such as a person’s overall health or general lifestyle, which is why it’s important to consider it thoroughly.
Still, it can provide a reassuring guideline when making financial decisions at the start of your retirement.
Make a retirement plan
As they say, if you fail to plan, you plan to fail.
Making a retirement plan is a great way to get your ducks in a row ahead of time, so you can feel financially confident through an undefined period of time like retirement.
You first need to consider what your expectations are for retirement.
Will you be globetrotting and ticking off bucket list items, or leaning into the tranquility of a peaceful life at home?
Having outlined this, you can look at what your monthly and yearly outgoings are likely to be. This is also a good way to help you decide which option is best for you when it comes to choosing how to receive your pension.
If you’re still feeling uncertain of your exact financial needs, it could be worth speaking to a financial advisor.
Keep your pension invested
People with a Self-Invested Personal Pension (SIPP) have the option to access their money from 55 (moving up to 57 as of 2028). Given this, it’s understandable that some folk want to dip into their pot before they’ve actually retired.
Still, resisting this temptation may lead to better outcomes in the big picture.
Leaving your money invested means you won’t miss out on the potential for growth. Then, when you’re retired, you can access the money you have when you really need it.
Just remember, you may need to update your pension provider if you’re planning to push back the date you retire.
Summary
At the end of the day, there is no cookie cutter solution to making your pension pot work for you. By first looking at how exactly you hope to spend your retirement, you can then dig into what approach is right for you.
If you’re looking to transfer your pension, Wealthify offers low fees, zero transfer charges (this excludes other providers who may charge for ‘transferring out’) and a team of investment experts who can manage your portfolio in a style that suits you.
Your tax treatment will depend on your individual circumstances, and it may be subject to change in the future.
With investing, your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.
Wealthify does not provide advice. If you’re not sure whether investing is right for you, please speak to a financial adviser.
References
[1] https://moneyweek.com/personal-finance/pensions/managing-your-money-in-retirement
