5th June 2019
Jonathan Watts-Lay, Director, WEALTH at work outlines some of the key considerations for individuals facing retirement.
1. What are your income options at-retirement? How to choose?
If you have a defined contribution (DC) pension (also known as a money purchase pension), you need to decide how to access your income at-retirement. You can choose between buying an annuity (this provides a guaranteed regular income in retirement, typically for the duration of someone’s life), taking income drawdown (this keeps your pension pot invested, whilst allowing you to take variable levels of income each year), or taking it as a cash lump sum. It doesn’t have to be just one choice as you could even choose a combination of options. Don’t worry if it sounds overwhelming – financial guidance and/or regulated financial advice can help you understand exactly what each option means and which approach best suits your needs. Speak to your employer about any support that they provide.
2. How much income will you have in retirement?
In addition to your personal situation it is also important to consider that of your partner, and to review all possible sources of income, including all defined benefit (also known as final salary pensions) and DC pensions, and other savings such as ISAs, shares and general savings.
You should also think about how much income you are going to need in retirement including essential income to meet your day-to-day living expenses (household bills etc.), and discretionary income for holidays, hobbies etc. Most people live longer than they expect, so keep this in mind when doing your sums. For example, the Institute for Fiscal Studies found that those in their 50s and 60s underestimate their chances of survival to age 75 by around 20% and to 85 by around 5% to 10%.
There’s a lot to think about – some people may feel like they can do this themselves but many will need help working through all the options so regulated financial advice will be a must.
3. Shop around
The FCA found that those who go into income drawdown could increase their annual income by 13% by switching from a higher cost provider to a lower cost provider. This is why it’s important to make sure that you shop around before you make any decisions about purchasing any retirement products. Don’t just go for the first option offered by your pension company (sometimes called the default option), as it may not be the best approach for you. It is crucial that you do as much research as possible to ensure that you select a retirement income option that best suits your needs. This means finding something which enables you to access the right amount of cash as and when you want it, and for as long as you need it.
4. Don’t pay more tax than you need to
A recent WEALTH at work poll found that 91% of employers believe their employees don’t understand the tax rules when withdrawing money from their pension. This is important as a report by the Pensions Policy Institute showed that individuals could end up paying 200 times more tax depending on how they decide to access their retirement income.
Typically only the first 25% of a DC pension is tax free; the remaining 75% is taxed as earned income. So you could find yourself paying more tax than you need to, if you don’t plan carefully. For example, some people have taken their pension as a cash lump sum, not realising that it could make them a higher rate tax payer! It is important to look at all your savings and work out the most tax efficient way of generating income. For example, it may be more tax advantageous to take income from your non-pension savings first, or to take smaller amounts each year from your pension, and then to top it up with withdrawals from your ISA as this is paid tax free.
5. Defined benefit pension transfers – is there a middle ground?
Increasing numbers of defined benefit (DB) pension scheme members have been transferring their pension into DC pension schemes, so that they can have flexible access over their pension savings. This process is referred to as a ‘defined benefit pension transfer’ and involves giving up your DB pension scheme benefits (also known as ‘safeguarded benefits’) in return for a cash value which is then invested in a DC pension.
Some of the cash values offered (also known as ‘cash equivalent transfer values’) can seem generous and extremely tempting for some individuals. But it can be difficult to know whether the transfer value being offered is as good as they seem and therefore need to be carefully considered.
It is a regulatory requirement that regulated financial advice must be sought to transfer a DB pension if its value is £30,000 or above, but there is no statutory requirement to take ongoing advice once the transfer has been made. This means that individuals could be taking on all of the future risk associated with managing their pension such as inflation, tax and investment risk, and there are no guarantees that their income needs through the duration of retirement will be met.
Some pension scheme providers have started to offer ‘partial transfers’ to their members, which means that only part of your DB pension will be transferred and the rest will remain in the scheme to provide a secure income in retirement. This could be a good option and middle ground for those wanting to benefit from flexible access to their pension savings, whilst also having the security of keeping part of it in their DB scheme. Partial transfers aren’t a common option yet as only about 15% of DB pension schemes offer it, but if you are considering a DB pension transfer, you should find out if your scheme provides this option.
6. Look out for scams
Scammers often use highly professional looking websites and marketing literature to lure you in, and they tend to sound completely legitimate when they contact you. It’s easy to see why so many people are fooled, and it isn’t small amounts of money which are being taken. It’s estimated that victims of pension fraud have lost £91,000 on average each, with latest reports indicating that some victims have even lost more than £1 million to fraudsters. So, whatever you’re planning to do with your retirement savings, it’s really important to check whether any company that you’re planning to use is registered with the Financial Conduct Authority (FCA). You can also visit the FCA’s ScamSmart website which includes a warning list of companies operating without authorisation or running scams.
7. Ensure pension beneficiary details are up to date
There is a rule in place which means that if someone with a DC pension dies before the age of 75, there is no tax to pay on their pension. This means that any remaining pension can pass onto your beneficiaries’ (the person(s) who inherit it) tax free. This is subject to not exceeding the current £1,030,000 lifetime allowance, and providing that the company pays out within two years of the date of death. If you die after turning 75, your pension beneficiary can choose to receive the money as a lump sum, or as an income, and will be taxed at their marginal income tax rate. So, it is important to make sure your pension provider(s) have up-to-date details of your beneficiary.
8. The importance of financial guidance and regulated financial advice – what’s the difference and where to get it?
This is a common area of confusion. Financial education or guidance helps you to understand your finances in general and provides generic options for you to consider. Whereas regulated financial advice helps you understand your personal financial situation and provides recommendations based on what is suitable for you. Pensions Wise provides free guidance but it only considers your pensions, and not your other savings and assets.
You may want to consider getting regulated financial advice as an Adviser would consider all of your savings (such as pensions, ISAs, deposit accounts and any other savings and investments) and work out the most tax efficient way for you to fund your retirement income. They can also help to put the plan into place for you and regularly review it over time to ensure it continues to meet your objectives throughout retirement.
Many employers offer financial guidance and support in the workplace which could help you put a comprehensive retirement plan together. Speak to your employer to see what support it has in place.