Thinking about what to do with your pension can be daunting. But you’re not alone. We’ve answered a few common questions you might have for when you start to think about taking a pension income.
What type of pension do you have?
The choices you have will depend on the type of pension you have. If you’ve got a pension where the amount you get at retirement depends on how much you pay in, you’ll have a ‘defined contribution’ or ‘money purchase’ pension.
These pensions are now the most common workplace pensions in the UK. If you have taken out a pension yourself – like a personal pension or a self-invested pension (called a SIPP) - it will also be a defined contribution pension.
Another pension that may be available through your workplace is a ‘defined benefit’ pension. These pensions promise specified benefits at retirement – usually an income for life based on the salary you had received.
It’s always worth double checking with your workplace pension provider to make sure you know what type you’ve got.
When and how do I take my pension?
The most basic rule that applies to pensions is that you usually can’t access your pension until you’re 55 (rising to 57 in 2028). And you don’t have to stop work to access your pension.
If you’re at least 55 - and you have a defined contribution pension – you have several options about how you access your pension pot.
This guide will help you understand what your options are and tell you about the pros and cons of each. This can help you to make an informed decision on what’s best for you.
- Leave your pension invested: if you don’t need to access your pension yet, your money could continue to grow as it stays invested.
- Take your pension savings as a single lump sum: 25% will be tax free and the remainder will be taxed at your marginal tax rate.
- Take a flexible income from your pension: This is known as income drawdown. You can take up to 25% of your pension pot tax-free, either in one go or as smaller lump sums. Whatever is left in your pension pot after you’ve taken your 25% tax free lump-sum remains invested. You can then tap into it whenever you need, and take either a regular income or lump sums as and when you need to. These ‘leftover’ amounts are treated as income, which are taxed at your marginal tax rate.
- Convert some or all of it into an annuity: This is a financial product that can give you an income for life. The rate you get depends on your personal circumstances, like your health and your age.
The good thing is you don’t have to pick one option over another. Unless you take your whole pension as a lump sum, you can mix and match and decide which options work for you.
What happens if you leave your pension where it is?
Because you can choose when to access your pension pot, you can also choose to leave it where it is until you need it.
And while it’s untouched, there’s no tax to pay.
The real benefit of this is that your pension should continue to grow – tax free. Of course, the return on your pension isn’t guaranteed. But if you leave it untouched, it should hopefully be worth more over the years.
If you do decide to leave your pension where it is, it’s worth double checking where your money’s invested. If most of it’s in company shares, you may find that it yo-yos if the stock market has some ups and downs.
You may choose to take less risk with your investments as you get older – and you should be able to switch your pension to other lower risk investments. If you’re not sure how to go about this, talk to your pension provider or you can pay for advice from an independent financial adviser.
You might also want to check how much your pension and investment provider is charging you to look after your pension. If charges are high, this could eat into any returns.
Can I cash in my pension in one go?
Take the whole amount as cash in one go and get up to 25% of this tax-free.
This might seem like a great way of taking control of your money. But there are some downsides.
For a start, only the first 25% of your pension is tax free – you’ll be taxed on the rest.
So, if you have a pension pot of £80,000 and cash it all in, the first £20,000 will be tax free – but you’ll pay income tax on the other £60,000 at your marginal rate of tax. There is the potential for your income in the current tax year to tip into higher bands, depending on your personal circumstances. This means you might end up paying more tax overall with this option, rather than if the withdrawals were spread out over multiple years.
If you decide to access your pension, you’ll have to decide what to do with the money. And how you plan to fund your retirement if you withdraw fully. If you put your pension money in a savings account, the interest rate may be lower than inflation – and that means your cash will be losing real value when compared to the cost of goods and services. That means you might not be able to buy as much in the future with your money as you can now.
What is a flexible income in retirement?
You can take an income from your pension pot, whilst it remains invested.
With income drawdown, 25% of your pension pot is tax-free and the rest remains invested. You can tap into it whenever you need to, and when you do, it is treated as taxable income.
You can take income from your pension whenever you need to. This can either be one-off payments, or you can set up regular withdrawals.
Income drawdown does have some disadvantages though. For a start, the charges can vary widely between different providers. This could include an annual charge, and a charge when you take money out.
There’s also a risk that you could outlast your pension, but this is true for any option you choose other than buying an annuity from a provider.
Not all pensions are set up for income drawdown, so double check with your pension provider first. If your provider doesn't enable income drawdown, you may want to transfer your pension.
What about an annuity?
An annuity provides you with a regular guaranteed income. There are different types of annuities available. Buying an annuity means you hand over some or all of your pension fund to an annuity provider. The amount you’ll get depends on how old you are, when you buy the annuity and your health (this may affect how long you’ll live for).
There are lots of different types of annuities. For example, you can buy one that’ll pay you an income that rises at an agreed level and may include payment of an income to your partner or spouse after you die. Or, you can buy one that will give you a guaranteed income for a fixed term.
If you buy an annuity, make sure you shop around first. People tend to buy their annuity from the provider they’ve saved with. But you don’t have to do this – and you could get a higher income for life by going elsewhere.
One other thing to keep in mind is that an annuity will normally finish when you die. Unlike with drawdown, where whatever is left in your pension pot can be passed on to someone else. If this is something that’s important to you, have a think about whether having part of your pension in an annuity (rather than all of it) works better for you and your personal circumstances.
Passing on your pension
It’s never nice to think about what’ll happen after you die. But it’s really important to do it. Apart from what you’ve used to buy an annuity, whatever is left in your pension pot can be passed on.
If you’re under 75 when you die, and if you haven’t taken money out of your pension pot, your beneficiaries won’t have to pay income tax on it. The only exception is if your beneficiaries are paid more than two years after your pension providers are told of your death.
If you’re 75 or over when you die, your beneficiaries would have to pay income tax at their marginal tax rate (this is their highest personal rate).
So, if your beneficiaries are normally basic rate taxpayers, but getting a payment from your pension puts them into the higher tax rate, they’d have to pay income tax on the money they received. This can be up to 45% of the value over the basic rate allowance in England, Northern Ireland and Wales and up to 48% in Scotland.
From 6th April 2027 any unused pension pot will be treated as part of your estate when you die. That means there might be inheritance tax to pay.
Where to find out more
Your pension provider can give you information on your pension options. You can also get some free help from the government-funded service, Pension Wise at MoneyHelper. Find out more at MoneyHelper.org Link opens in a new window or give them a ring on 0800 138 3944.