When you’ve built up savings in a pension scheme, it’s a valuable asset waiting to be optimized. Anyone standing at the brink of retirement should ensure they are well-informed about the array of choices available when it comes to turning pension savings into income.
In the UK, as elsewhere, the options available are largely fuelled by the type of pension scheme where your savings are held. It’s important that consumers understand their scheme type in order to avoid confusion about income options.
Traditionally, pension schemes were of the ‘defined benefit’ type – perhaps more commonly known as ‘final salary’ or ‘average salary’ pensions. These schemes pay a guaranteed income for life from retirement age, based on a percentage of the employee’s final or average salary.
Defined benefit schemes are becoming rare nowadays, especially in the private sector, as employers have found them difficult to fund. People in such a scheme will tend to take the benefit of a guaranteed and often generous income, rather than choose a potentially risky option or ‘transferring out’ to another type of scheme.
Most UK retirees will however find that some or all of their pension savings are in a ‘defined contribution’ scheme, also referred to as a ‘money purchase’ pension. Instead of an income being based on salary, these schemes build up a fund (pension pot) from which the individual can choose how to create an income. Income can be taken at any age from 55, but the longer people leave it, the higher income payments they are likely to achieve.
So, what are the income options from a defined contribution pension pot? Two of the main options are annuities and flexi-access drawdown.
For anyone looking to lock down a risk-free option, an annuity may fit the bill. This offers a pathway to transform your pension savings into a guaranteed income for life or a fixed term. While your savings cease to be invested, providing stability, the trade-off is the absence of potential growth if the stock market performs well. You can find out how much income you are on track to receive with an online annuity calculator or by consulting with an annuity broker or financial adviser.
For those willing to navigate some investment risk during retirement, flexi-access drawdown might be the answer. Here, your pension savings remain invested, allowing for potential growth, though at the risk of losing money in unfavourable market conditions. An upside lies in the flexibility to make withdrawals at your convenience, as opposed to the fixed income level of an annuity.
It’s not an ‘either or’ decision; instead, consider blending these options to create a personalized retirement income plan. Carefully assess the pros and cons of all your options, and make a decision based on your lifestyle, other assets and income level you need.
And if you need more income beyond what your personal pension and the State Pension can pay, here too you have options, starting with drawing on savings or investments. With interest rates on the rise in recent years, millions of UK savers have found themselves in a fortunate position. And in a move to foster increased consumer saving, the UK typically allows the first £1,000 of interest earned on savings each year to be tax-free.
However, the reality for many retirees is being ‘asset rich, cash poor.’ While they may own property, their savings or investments are limited. For those in this situation, options are there for transforming property equity into much-needed cash. Some choose to downsize to a smaller property or one in a more affordable neighbourhood, converting their property value into tangible funds.
Alternatively, there’s the avenue of equity release, where retirees can leverage the equity in their property without having to sell or move home. The loan plus interest is repaid when they pass away or move into long-term care, so there are no mandatory monthly payments to make.
An initial step involves using an equity release calculator to determine how much cash can be released through a lifetime mortgage, commonly known as a reverse mortgage. This innovative approach isn’t for everyone as it can ultimately be an expensive way to borrow. But it opens up new possibilities for retirees seeking additional financial flexibility in their golden years.
Remember: this article is for information only and it’s no substitute for taking professional advice or guidance before making important decisions about your retirement income.