Posted: Thu 26th May 2022
This guide is sponsored by PensionBee.
In part 5 of this guide, we examined some of the main considerations around planning for retirement.
Effective retirement planning is all about starting early and, among other things, understanding how much you'll need to live comfortably and how much you've already saved. If there's a difference, you need to know the best ways of making up the shortfall.
But what happens when you've done all of this and you're ready to start withdrawing those years of pension savings? What options do you have when it comes to finally enjoying your pension?
In this final part of our six-part guide, we explain when and how you can access your pension. We also look at the State Pension and when you'll start to receive those payments too.
Listen to episode 2 of PensionBee's Pension Confident Podcast: Keeping your self-employed pension on track
When can I withdraw my pension?
You can begin taking money from your personal pension as soon as you turn 55 (57 by the year 2028). However, if you prefer, you can defer your pension and leave the money where it is (see Can I delay my pension? below), which has a number of benefits.
Can I withdraw my pension before 55?
This is known as early pension release, or pension unlocking. Withdrawing pension money before the minimum age of 55 (57 from 2028) often means having to pay a significant tax penalty (up to 55%), as HMRC will view a withdrawal of this nature as 'unauthorised'.
For this reason, most reputable pension providers warn against it and don't allow unauthorised payments to be made from their schemes. So, beware of anyone who claims to be able to help you access your pension prematurely.
There are some exceptions to the rule. For example, if you have poor health or a serious medical condition, you might be able to access your pension early, without financial penalty.
Unfortunately, there are firms out there that advertise services to help people under 55 release their pensions early, and charge hefty fees for doing so. These firms typically aren't authorised by the Financial Conduct Authority – giving you no protection if something goes wrong – and are often running financial scams.
Can I delay my pension?
Yes – this is called a deferred pension. When you defer your pension, you're leaving the money where it is and taking it later in life (in your early 60s, for example). This can benefit you because your savings have more time to grow, potentially giving you a more comfortable income in retirement.
When you defer your pension, you can carry on making contributions or stop them altogether. If you decide to keep paying in, you'll generally receive tax relief on your contributions up to the age of 75.
You can defer your State Pension as well. As with your personal pension, you're giving your State Pension longer to grow. Deferring your State Pension can also increase your payments, and you may be eligible for a lump sum.
How do I withdraw my pension?
As you get closer to the age of 55 (57 from 2028), your pension provider will contact you to ask what you want to do with your personal pension. They might send you forms to fill in or allow you to make decisions online via their website or app.
As mentioned above, you don't have to take your pension at that point. You can leave it where it is until you're ready to withdraw from it. This might be some years down the line. But if you do decide to withdraw your personal pension, here are your options:
Take a cash lump sum
Once you turn 55 (57 from 2028), you can take some or all of your pension as a cash lump sum. The first 25% you withdraw (called a pension commencement lump sum, or PCLS) is tax-free, but you'll pay income tax on the remaining 75%.
This is because you didn't pay income tax when you made the contributions initially, and because the government classes your pension as part of your total yearly earnings for income tax purposes.
You'll pay 20% income tax if you're a basic-rate taxpayer, 40% if you're a higher-rate taxpayer and 45% if you're an additional-rate taxpayer. Your income tax band may change depending on how much of your pension savings you withdraw, and if you're still earning an income from other sources.
As soon as you take any amount from the tax-free 25%, part of your pension becomes 'crystallised'. You must then decide what you'll do with it. You can:
Pros and cons of taking a lump sum
It's a source of income whenever you need it.
You can take 25% of your pension tax-free.
Taking only part of the pension and leaving the rest invested means it might continue to grow, increasing your savings.
Withdrawing smaller lump sums could make your income tax payments more manageable, as you can take some tax-free and some taxable without needing to take the entire 25% upfront.
Depending on how much you withdraw as a lump sum, you may end up paying more income tax.
Once you've taken the full 25% tax-free portion, you can only receive tax relief on pension contributions up to £4,000 each year, rather than £40,000. (This is known as the money purchase annual allowance (MPAA).)
Taking too much money from your pension too early could mean you run out of money later in retirement.
Leave the money invested (income drawdown)
Drawdown means leaving your pension money invested, and withdrawing cash from your pension pot whenever you need it.
It isn't like an annuity, which provides a regular, guaranteed income. Instead, it lets you take some of your pension as cash while leaving the rest invested, so you can continue to benefit from your investments (providing they perform well). It's the most flexible way of taking money from your pension, and is the main alternative to buying an annuity.
Your money moves into drawdown once you take a tax-free lump sum. When this happens:
your savings stay invested (typically in a combination of shares, cash and bonds)
you can switch to different funds and investments
you can withdraw as much or as little as you like, at any time (you'll pay income tax on anything you take over your 25% tax-free amount)
Since pension rules changed in 2015, all new income drawdown products are flexi-access drawdown. This means that when you put your money in income drawdown, you have access to your savings whenever you need them, while the funds left in your pension pot remain invested.
With flexi-access drawdown, you can choose how much money to take from your pension each year. But remember: once you've taken the 25% tax-free amount and gone over your personal tax-free allowance for the year, you'll start to pay income tax on any further money you withdraw.
Pros and cons of income drawdown
The most flexible way of taking a retirement income.
If the funds that stay invested perform well, your pension pot could rise in value.
If you die before you're 75, your beneficiaries can inherit the money in your pension drawdown product without paying tax.
If you choose drawdown but change your mind later, you can use your pension pot to buy an annuity.
The growth of pension funds depends on how well markets perform, so your pension pot could lose value.
Your pension money could run out if you take too much or you live longer than you expect.
Buy an annuity
An annuity is a financial product that gives you a stable income in retirement. When you buy one, you essentially 'sell' your pension pot to an insurer. The insurer then pays you a fixed income every month for a set period or the rest of your life.
You can use some or all of your pension to buy an annuity, and providers generally offer the following types:
Lifetime annuity: This guarantees you a fixed income until you die.
Investment-linked annuity: This pays a regular income that can rise and fall (depending on how investments perform) but will never drop below a certain amount.
Enhanced annuity: This usually provides a higher income, and is for people whose life expectancy is quite low (because they suffer from ill health, for example).
While the main benefit of an annuity is the guaranteed income it provides, you do lose the flexibility you'd have with income drawdown, for example.
If you'd rather be more flexible with your savings, you could spend only part of your pension on an annuity. For example, take out a 25% tax-free lump-sum, spend 50% on an annuity, and leave the remaining 25% in your pension to grow.
Pros and cons of buying an annuity
You have an income for either a fixed period or until you die. Unless you choose an investment-linked annuity (which pays out depending on how well its investments perform), you'll receive a regular fixed income, meaning greater peace of mind.
Some annuities rise with inflation, so you don't have to worry about your money not going as far in later years.
Some annuities have features that pay out to beneficiaries if you die before receiving the amount you bought it for.
Once you're locked into an annuity plan, you can't go back, nor can you change any of its conditions (including the amount it pays out), exchange it for another annuity, or 'cash out' for a lump sum.
You can't access the money in your annuity, as you might with a pension.
Lifetime annuities don't increase even if annuity rates (the percentage a provider pays out each year based on your initial payment) go up.
When can I withdraw my State Pension?
You can claim the State Pension once you reach State Pension age. This is currently 66 for men and women, although it's set to increase to 67 by 2028 (and to 68 a decade later).
As it stands, you won't receive your State Pension automatically. Instead, you'll need to claim it, and you'll receive a letter a few months before you reach State Pension age with instructions on how to make a claim. The current system allows you to claim online, over the phone or by post.
Deferring your State Pension
While you can start withdrawing a personal pension at age 55 (57 by 2028), you can't claim State Pension until at least 10 years later. By that time, if you're taking retirement income from other sources or you're still in self-employment, you may want to defer (delay) your State Pension.
By taking your State Pension just a few weeks later, you could receive a higher weekly amount or even a lump sum payment. The option for a lump sum is only available if you first delay receiving regular payments.
Unlike with a personal pension, you can't cash in the State Pension as a lump sum.
*You should not regard anything in this blog as financial advice. And when you're investing, as with all investments, capital is at risk and the value can go down as well as up.
Read the other parts in this series: