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My income options at retirement

How long will your money last? Can you maintain your current lifestyle? Should you take a lump sum? Should you buy an annuity? Do you stay invested and draw an income? Will your retirement income be taxed?

There are many questions to consider when it comes to taking your retirement income and a key one is deciding where that income is going to come from, and in what order it’s taken. If you’ve had more than a passing interest in your finances over the years, your tax-efficient pension is probably where most people think retirement income starts. But, if we want to maximise the efficiency of our income and enjoy as comfortable a retirement as possible, it’s not necessarily the first place we should turn to. Instead, we should be thinking of all our savings and investments collectively and getting advice on the most effective income strategy. Because, with the right planning it’s possible to enjoy a very comfortable level of income in retirement that significantly reduces, or possibly even eliminates, income tax charges.

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The three top objectives in retirement were peace of mind, not running out of money, and having enough money to leave behind to children. And the biggest financial regret? Not starting a pension sooner.

Interactive Investor’s Great British Retirement survey, October 2019

Things to consider when planning how to take your retirement income

Can I maintain my lifestyle in retirement?

How long will my money in retirement need to last?

What should I do with my pension when I retire?

Should I defer my state pension?

At what age can I take my pension?

Can I maintain my lifestyle in retirement?

Can you afford regular trips abroad? Can you start a new business? Can you afford to buy that holiday home by the sea? Can you support the kids and still not have to cut back? Whatever your goals in retirement our financial planners can model your likely living expenses and income and run through a range of scenarios to see what happens when your choices, needs or circumstances change. This approach, known as cashflow modelling, helps answer the key questions such as: What’s the most tax-efficient way to take an income in retirement? Will I need to downsize or sell any other property assets? Will I leave an inheritance tax liability, and how can I reduce it? As cashflow modelling makes a number of assumptions based on spending, potential income and many other factors, any of which could change over time, it’s not a guarantee of how things will pan out, but it will give you a good sense of the lifestyle you can achieve into and throughout retirement.

How long will my money in retirement need to last?

Given our increasing lifespans and the fact many of us are leading more active and healthier lives, most experts suggest that we should plan to make our retirement money last about 30 years. But, knowing how long our money will last in retirement is one of life’s big imponderables. The fact is, whilst we can estimate our outgoings and retirement income, none of us can predict inflation, interest rates, unforeseen expenses, or investment returns. Yet, whilst there’s no failsafe way to calculate how much you’ll need, there are some recognised guidelines, namely the ‘Multiply by 25 Rule’ and the ‘4 Percent Rule’. The ‘Multiply by 25 Rule’ estimates how much money you'll need to have saved when you come to retire. For example, if you want to withdraw £40,000 per year from your retirement portfolio, you’ll need to have saved a total of £1 million. The ‘4 Percent Rule’ guides how much money you may be able to safely withdraw each year as a percentage from your retirement savings, without significantly cutting into your investment capital. Some experts criticise these rules as being too optimistic, especially for retirees who prefer lower risk, lower return investment options. People who want a more conservative approach could instead opt for a ‘Multiply by 33 Rule’ and a ‘3 Percent Rule’, which also makes sense considering we’re living longer.

What should I do with my pension when I retire?

When you decide the time is right to access your pension(s) investments you generally have three main options –buying an annuity, taking drawdown or making lump sum withdrawals. Buying an annuity is the one option that offers a guaranteed income for life, but it’s important to recognise that annuities usually can’t be changed once set up and many commentators see them as offering poor value. Drawdown gives you more income flexibility in retirement. Your pension fund stays invested, you choose what income to take and your capital could still grow. But drawdown does come with more risk as your capital could fall in value, particularly through difficult investment cycles and if the income you draw is too high for the capital you have. Whether through investment performance or drawing too much (or too soon), your income is never guaranteed. The third option, imaginatively known as Uncrystallised Funds Pension Lump Sum (UFPLS) is to take lump sum withdrawals from your pension, which you can do in one large lump or several smaller pots. 25% of the amount is usually tax-free and the rest is usually taxable. It’s important to know you’re not restricted to choosing just one option, and it’s equally as important to know that not every pension provider allows every option.

 

You can mix and match all of the above to create the best retirement income solution to suit you. But, choosing the right path is not easy andthe wrong decision could impact your ability to enjoy a comfortable retirement, so getting professional advice is crucial.

Should I defer my state pension?

If you have enough income to meet your needs at retirement, whether using ISA’s, a lump sum or other income, it can make sense to defer taking your state pension. If you reached state pension age before April 2016, your state pension increases by the equivalent of 1% per cent for every five weeks you defer, which works out as an annual rate of 10.4%. You can also take this deferred amount as a lump sum as long as you have deferred for more than 12 months. This lump sum will include interest of 2% above the Bank of England base rate.

 

If you reach (or reached) state pension age after April 2016, the rate of deferral is less, at just 1% for every 9 weeks, which works out as an annual rate of 5.8%. If you fall into this age bracket, you sadly do not have any lump sum option.

At what age can I take my pension?

The earliest age that funds in a private pension can be accessed is 55 (rising to 57 from 2028), but there is no upper age limit, so you can leave it invested as long as you like. It is then usually possible to take up to 25% tax free and the rest is taxed as income - however, not every pension product or provider will allow you to stay invested, take a tax free lump sum, or both, beyond age 75.

 

You should also note that any entitlement to take a tax-free lump sum after age 75 dies with you, i.e. it cannot be passed on to a beneficiary. You can claim state pension when you reach the state pension age. For men and women, this is currently 65, increasing to 66 by October 2020. The state pension age is then scheduled to rise to 67 between 2026 and 2028. The amount you receive will depend on how many qualifying years of National Insurance (NI) contributions you have.

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The team at Investec have brought this [pensions] to life for me, giving me a real feeling of control and confidence over what is now my principal source of income.

Simon F, Leeds

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Tax efficiency in retirement

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