What should I do with my pension pot at retirement?

19th Mar 2024 Pensions & Retirement

6 min read

It’s a good idea to understand your pension options before retirement as it will be your main source of income. This article will reveal your options with your pension pot, including accessing your lump sum.

By now, you should have one or more workplace or personal pensions, which you can usually access from the age of 55. The age you can access your pension will rise to 57 in 2028.

Accessing your pension involves careful planning, as this money may need to last decades. We look at the options for drawing your pension and key issues to think about. We’ll mainly focus on defined contribution pensions as defined benefit (DB) pensions work differently.

When can I access my pension?

If you have a defined contribution pension, you can legally access this from the age of 55 (rising to 57 in 2028).

However, that doesn’t always mean that you should. Your pension has to support you during retirement, so you should wait as long as possible before accessing it.

Some advisers recommend spending other savings before accessing any pensions, as these are not subject to inheritance tax (IHT), while savings and other assets are.

You don’t need to be retired to access your pension, so you can continue to work full-time, but your pension income is subject to tax, so if you’re still working, your tax bill will be higher.

What if I delay my retirement?

You don’t have to access your pension the moment you’re legally allowed to. You can leave your pension invested until you need it.

It’s worth checking if your pension provider uses ‘lifestyling,’ an investment strategy where your pension fund is automatically switched to a lower-risk one as you approach retirement.

It’s worth remembering that you need to claim your state pension, and you can defer it. If you do this, you’ll receive an extra amount in addition to your usual payment when you claim the state pension.

If you reach state pension age on or after 6 April 2016 and delay claiming it, your state pension will increase by 1% every nine weeks you defer or around 5.8% if you delay for a year.

But if you reached state pension age before 6 April 2016, your state pension will increase by 1% for every five weeks you delay claiming or around 10.4% if you defer for a year.

Image of an older lady sat at a table contemplating her retirement

Image source: https://unsplash.com/@juanimsanchez

Are your benefits affected when you access your pension?

Some benefits are based on income, savings, and investments, so you may become ineligible for certain benefits if you access your pension.

It also depends on if you have reached pension credit age.

If you’ve reached pension credit age, money from your pension you would be entitled to, and any funds you withdraw will be taken into account when working out your income.

But if you’re under pension credit age, only funds you withdraw from your pension are considered as income.

Be aware of pension scams

You’ve worked decades to build up your pension, so it’s important to protect it from scammers. There are many ways scammers try and steal your money, including offering fake investments with unrealistically high returns.

It’s worth being wary of red flags, including unsolicited contact, especially as there has been a ban on cold calling about pensions since 2019.

Scammers will try and push you into making a decision by often claiming it’s a limited time offer.

Also, they may tempt you with a free pension review or offer to help you access a pension before the age of 55, the latter of which is usually not possible.

Scammers may imitate genuine firms, who would never contact you without your permission.

What are the main pension options?

You have many options for accessing your pension to choose from, each of which has pros and cons, while some can be used in combination with others.

Your main pension options include:

Withdrawing a 25% tax-free lump sum
Buying an annuity
Setting up drawdown
Withdrawing taxable lump sums

Withdrawing a tax-free lump sum

You can take up to 25% of your pension tax-free.

The easiest way to do this is in the form of a single lump sum, which can be appealing if you want a larger sum to spend early on in your retirement.

However, you need to understand how much you can afford to spend, so you don’t overspend.

It’s worth stressing you don’t need to spend it at all and you can reinvest some or all of it as a source of extra funds to draw upon in the future.

This may be a useful strategy if you are using drawdown as there may be times when it is a good idea to reduce your drawdown income temporarily.

Accessing the rest of your pension pot

Once you have accessed your tax-free lump sum, any extra money you withdraw from your pensions is taxable as ordinary income.

You have many options for taking this income.

These are:

Buying an annuity, which offers a guaranteed income for life or a set period of time.
Setting up adrawdown scheme to offer flexible access to the rest of your pot. to the rest of your pot.
Withdrawing one or more taxable lump sums.
A combination of two or more of these.

Now we’ll explore each of these pension options in more detail.

Buying an annuity

You can exchange some or all of your pension pot for an annuity, a type of insurance product that guarantees income for the rest of your life or for a set period of time.

A major disadvantage of an annuity is that you can’t vary the amount you receive after you have bought one, and it could be many years before you get back as much as you paid.

You can arrange for an annuity to pay an increasing amount each year, to beat inflation but this will cost you more initially.

You can also buy a joint annuity to cover your spouse, which will continue to pay out a reduced amount after your death, for as long as they live, although this will also cost you more.

If you have a health condition, you may be able to buy a more valuable enhanced annuity.

Find out more about the pros and cons of an annuity.

Setting up a drawdown scheme

You can have some or all of your pension pot reinvested into a drawdown scheme.

One of the biggest advantages is flexibility. You can draw as much or as little as you need every year, and the money is taxed as ordinary income. However, your pension pot will shrink over time, so you may run out of money.

Also, a key risk is your money is exposed to the stock market, so it can fall in value as well as grow, which may significantly shorten the life of your pot.

If you take money out when the market is falling, it will be harder for the rest of your pot to recover.

It’s worth considering keeping some of your tax-free lump sum as an emergency reserve in case the stock market struggles. This means you can reduce your drawdown income and minimise the impact on your pension.

Find out more about the pros and cons of drawdown.

A taxable lump sum

You can draw the whole of your remaining pension pot after withdrawing your 25% tax-free lump sum, but the remaining 75% will be taxed as ordinary income.

For larger pots, you can lose a big chunk of your money due to a hefty tax bill, so it’s worth taking financial advice if you’re considering this.

If you have a small pension pot you don’t want to combine with other pensions, withdrawing it all as a lump sum may be a practical solution.

Before accessing your pension, it’s worth talking to a financial adviser first.

A combination of methods

It can be stressful trying to make a decision about accessing your pension, but you don’t have to choose one option or the other exclusively.

You can use a range of different strategies for taking income from your pension so you benefit from both flexibility and security.

For example, you could set up a drawdown scheme for the first part of your retirement and then, when you are older, use the remainder of your pot to buy an annuity.

As you’ll be older, you may be able to qualify for an annuity with a higher rate.

Alternatively, you could set up a small annuity to cover your essentials and withdraw extra income via drawdown.

Drawing a final salary pension

A final salary pension, which is also called a defined benefit pension, is a type of workplace pension that works differently.

Instead of building up a pension pot, it pays a guaranteed income from a certain age. Some final salary pensions will also allow you to take a tax-free lump sum.

You don’t need to do anything to draw a final salary pension, as it will be paid to you automatically from the date specified by your scheme. This is your ‘normal retirement date’ and is usually set around 60, but could be earlier or later.

You may be allowed to transfer from a final salary pension by exchanging your guaranteed pension benefits for a pension pot of a certain value.

While there can be advantages, there are also significant risks, so you speak to a financial adviser if you’re considering this.

What should I do with my pension pot?

The choice you make with your pension should be based on your own circumstances and goals.

It’s worth talking to a financial adviser, as they will help recommend the best course of action.

Your pension strategy may change during retirement, to reflect your circumstances, so expert advice can ensure it is properly tailored for your needs.

If you plan to access your pension from the age of 55, see our article on retiring early.

You can estimate how much annual income to expect when you retire using Unbiased’s pension calculator.

Pensions can be complex, so financial advice is worthwhile to avoid an unnecessary or hefty tax bill.

Unbiased can connect you with a financial adviser regulated by the Financial Conduct Authority, who can recommend the best way to access your pension.