The global pandemic has left many people hoping to retire this year unsure of what to do next. Romi Savova, chief executive officer at PensionBee and member of the loveMONEY Expert Panel, reveals what you should consider before doing anything.
Retiring during a global pandemic is unlikely to conjure up the relaxing change of pace soon-to-be retirees had hoped for when they planned their wind-down from work.
For those with Defined Contribution or Self Invested Personal Pensions, which are invested in global stock markets, volatility in share prices over the last six months has likely created huge peaks and troughs in the value of their pots.
While the current environment is obviously exceptional, it's worth remembering that volatility is a normal, if not always welcome, part of investing.
It's more important for retirees to think about what they actually want to achieve with their pension pots before taking any action that may be irreversible.
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Getting an income in retirement
First, it’s vital to figure out how you want to draw an income during retirement.
Below are the three main options, but it’s possible to mix and match by splitting your pension pot between them.
1. Guaranteed income
Some people find that fixing the amount of pension they receive each month is a good way to make sure they can cover their regular bills.
The most common way to get a fixed income guaranteed for life, or a set number of years, from your retirement pot is to buy an annuity.
This was pretty much your only option a few years ago, but the introduction of pension freedoms triggered a sharp fall in annuity rates, making them far less attractive than they once were.
You can take your 25% tax-free allowance, then buy an annuity with some or all of the remaining 75%.
But you will pay tax on your annuity income (where your total income is over £12,500 a year).
According to the Money Advice Service calculator on 28 July, for a 60-year-old with a £100,000 pension pot, the average annuity is £2,197 a year, which rises in line with inflation.
If you are interested, it’s best to shop around different providers to get the best rates – and remember buying an annuity is irreversible. So, you should be confident that your annuity meets your needs before signing on the dotted line.
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2. Flexible withdrawals
With this route, you gain flexibility, although your income is no longer guaranteed. So, your income may fluctuate depending on how the investments in your retirement pot perform.
There are two options to take your pension flexibly:
- Flexi-access drawdown: This is the most common option, enabling you to take up to 25% of your pension pot tax-free, and keep the rest invested. You can arrange for a percentage of what is left to be paid to you as a pension on an ad-hoc basis. The value of your pot can fluctuate and is taxable.
- Uncrystallised Funds Pension Lump Sum: Instead of using your 25% tax-free allowance in one go, you can spread it across a number of withdrawals. Every time you take money from your pot, 25% is tax-free and the other 75% is taxed at your marginal rate.
3. Keep an investment pot
Just because you have reached your pension policy’s retirement age, doesn’t mean you have to take the money and run. You can leave your pension fully invested until you need it.
Leaving your money in an investment pot gives it more time to grow. The later you start withdrawing from your pension also means it is likely to last you longer.
You don’t pay tax on the money while it stays in your retirement pot, and any amount in there can be passed on tax-free to loved ones if you die before age 75.
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What you should avoid
Whatever options you ultimately choose from the above will depend on what’s right for your individual circumstances.
But there are certain things you should avoid no matter how you decide to withdraw your pension.
Making large withdrawals when markets are down
Taking big chunks of cash out of your pension when stock markets are falling is a bad idea as it forces you to sell your investments when their value is going down.
This means you may have to sell more to get the income you need, which will deplete your pension at a faster rate and make it more likely that you’ll run out of money.
High pension fees
Not all pensions are made equal, and what each provider may charge you to withdraw your cash over the duration of your retirement may vary wildly.
In some cases, you could deplete your pension by tens of thousands of pounds over a long period of time due to high pension fees.
Shop around different providers to compare charges, and demand they show you the cost in pounds and pence for any fees over the lifetime of your pension.
Moving everything to cash
A recent survey by PensionBee found 20% of those aged 55 and over would withdraw their pension ‘for control.’
Often, this can mean dumping a large portion of a retirement fund into a cash savings account.
This is bad for two reasons. Firstly, taking more than 25% from your pension triggers tax charges, and the more you take in one go, the bigger that tax charge will be.
Once you have withdrawn the 25% tax-free amount, you will need to pay up to 45% Income Tax on the remaining amount.
Secondly, cash savings accounts are paying tiny amounts of interest that are not even keeping up with inflation, so instead of having your money invested in a pension with the potential to grow, your savings will likely fall in value.
Most people don’t need more than around three months expenditure in a rainy-day cash fund.
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Get impartial advice
Before you do anything with your pension pot, work out which withdrawal option, or options, will work best for you.
This will be based on the type of income you need: guaranteed or flexible – or maybe you’ll choose to do nothing for now so you can stay invested and increase the chance that your pot may grow.
It’s generally recommended that you get free, impartial advice on how to prepare financially for retirement from Pension Wise, a Government-backed service.
Or you can speak to a regulated financial adviser, who will charge a fee but could offer invaluable help with your immediate and longer-term retirement planning.
This article was written by Romi Savova, CEO of online pension provider, PensionBee.
The information included in this article does not constitute regulated financial advice. You should seek out independent, professional financial advice before making an investment decision. Please remember the value of your investment and any income from it may fall as well as rise and is not guaranteed. You may get back less than you invest.