Our 50s and 60s is often when we review where our retirement savings are invested in the run up to needing them, and also when we think about what we’ll do with this money when we stop working.
Many of us believe that saving for retirement means contributing only to a pension, but there are other ways to build your savings as you approach retirement that you might want to consider, if you haven’t already.
That said, there are many advantages to pensions, not least that they encourage you to set aside money solely for your retirement, and you get help from the government in the form of tax relief on money you pay in. But they’re not the only retirement saving option, particularly if you’re looking for a bit more flexibility as to when you can access your money.
Here, we explain the various choices available to you, some of the pros and cons of each, and where you might want to invest your retirement savings.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
What are the main benefits of pensions?
One of the big advantages of continuing to pay into a pension as you approach retirement is that it gives you tax relief on money you pay in, and you can continue to benefit from this right up until you reach the age of 75. That means:
- If you pay tax at the basic rate (20% in the 2024/25 tax year) £100 paid into your pension will only cost you £80.
- If you pay tax at the higher rate (40% in the tax year 2024/25) £100 paid into a pension will cost you £60.
- If you pay tax at the additional rate (45% in the tax year 2024/25) £100 paid into a pension will cost you £55.
If you’re a particularly high earner, you may get a lower Annual Allowance. For example, for every £2 of income you receive over £260,000 in the 2024/25 tax year you’ll lose £1 of your Annual Allowance, so if your adjusted income is over £360,000, your Annual Allowance will shrink to just £10,000. Learn more in our guide How do pension allowances work?
Another major benefit of pensions is that they can currently be passed on free of Inheritance Tax (IHT), and completely tax-free if you die before age 75. If you die after the age of 75, your pension will be taxed in the same way as income when your beneficiary (or beneficiaries) come to make a withdrawal. Learn more in our article Can my pension be used to reduce inheritance tax?
However, under changes announced in the October 2024 Budget, this is set to change from April 2027, as pensions will be brought into the scope of Inheritance Tax from this date. Not only will your loved ones after April 2027 potentially face a bigger Inheritance Tax bill when you die, but if you pass away after the age of 75 they will still have to pay income tax at their marginal rate of income tax on any income they receive from your pension, in the same way as you would have. This means that they could end up facing a double tax hit on any pension savings you leave. You can find out more about these changes in our guide Budget 2024 pension changes, and about what you might be able to do about them in our article 5 ways to beat pension Inheritance Tax Budget changes.
Disadvantages of pensions
- Money is locked away until age 55 (this will rise to 57 from 2028). That means if, for example, you lose your job or your relationship breaks down and you need extra money in your early 50s, you won’t be able to raid your pension fund. You can cash in your pension before the age of 50 and take the money as a lump sum if you’re in ill health, but the conditions are extremely strict. You have to be seriously ill and have less than a year to live.
- You have to pay income tax on the monthly income you receive from your pension, although you can take a tax-free cash lump sum of up to 25%. Find out more in our article How much tax-free cash can I take from my pension?
- You have to convert most of your pension into a monthly income. The two main ways of doing this are by using your retirement savings to buy an annuity, or guaranteed income for life, or to leave them invested and draw an income from them as and when you need them via pension drawdown. If you decide to buy an annuity, bear in mind that there can be quite a difference between the best and worst annuity rates so it’s definitely worth shopping around.
Is an ISA an alternative?
There was a time when the retirement mantra from some financial advisors was ‘pension, pension, pension’ but these days it’s not that straightforward. The truth is that the worst thing to do is to save nothing towards your retirement. How you do it is up to you.
An ISA or individual savings account, is simply a tax-free savings or investment account, lets you pay in a limited amount every year (currently £20,000 in the 2024/25 tax year) and because your money isn’t locked away, you can always get at it if you really need to.
There are some advantages to using an ISA:
- You don’t have to pay any tax when you cash it in. Money you take out of an ISA is free of tax.
- You can cash in your ISA or take money out of it at any time. Unlike a pension, where your contributions are locked away, you can usually get at any savings that you’ve paid into an ISA any time you want to. Bear in mind, however, that the company you buy your ISA from may put some restrictions on it. For example, if you take out an ISA that’s designed to run for a fixed length of time, there may be a penalty if you take money out of it early.
- Your ISA payout income is treated differently to pension income. If you’re likely to retire on a low income, you might qualify for a state benefit called Pension Credit. It guarantees you an income of £218.15 a week (in 2024/25). There’s a complex formula that’s used to calculate how income from savings and investments is treated when assessing whether you can claim Pension Credit or not, but it could mean you’d qualify even if you have money in an ISA. You can find out if you’re eligible for Pension Credit and how much you can get using the Gov.uk Pension Credit calculator.
The main disadvantage of ISAs is that you don’t get tax relief on money you pay into a pension. It means you miss out on that ‘instant boost’ boost that tax relief gives you.
Bear in mind that you can use a combination of pensions and ISAs if you want to, as both offer valuable benefits. Find out more in our article Is it better to save into an ISA or a pension?
Where should I invest my retirement savings?
Unless you’ve specified that you want your pension savings to be invested in a particular fund or funds, you’re likely to find that your contributions have been automatically invested into a ‘default fund’. You can find out more about how default funds work in our guide Where is my pension invested?
The default fund typically uses what is known as ‘lifestyling’ which means your pension investments automatically change as you approach retirement. When you’re a long way off retirement, for example, your money will go into a fund invested in a broad mix of investments, but predominantly stocks and shares, with the aim of growing your pension pot.
As you start to approach retirement, usually when you’re in your late fifties, your savings will gradually be moved into less risky investments, such as gilts (which are government bonds) and cash. This is to reduce the risk of your pension suddenly plummeting in value just before you retire, which might happen if there was a sudden stock market crash and all your money was in shares. However, when it comes to retirement planning, it’s rarely a case of one-size-fits-all. This means that the default fund may not be the best option for you, based on your investment timeframe and your approach to risk.
If you’d rather choose an alternative option, ask your pension provider which funds you can invest in. They should provide you with information about all the options available to you. You can find more detailed information in each fund’s Key Investor Information Document (KIID). The KIID explains the fund’s investment objectives, charges and other information.
You’ll typically be able to choose from cautious, balanced or more adventurous options, so you can find a fund which matches your appetite for risk as well as your investment timeframe. Remember to take charges into account too, as the higher they are, the more they’ll eat into your investment returns. You can find out more about choosing pension investment funds from the Pensions Advisory Service.
Once you reach retirement, if you decide to use drawdown to provide yourself with an income, again where you decide to invest your pension savings will depend on your approach to risk, and your financial objectives.
Unless you’re an experienced investor, it’s not always easy to work out which investments to choose, so it’s worth seeking professional financial advice about the best options for you. It’s also a good idea to speak to an advisor if you’re worried that your existing pension investments are underperforming – they should be able to suggest alternative investments that may hopefully generate higher returns.
If you opt not to seek advice, rules were introduced in 2021 to help drawdown customers decide where their pension savings should be invested. Essentially, these rules mean that you’ll be presented with four different objectives by your pension provider, and asked to decide which one applies to you. This will then determine which ‘Investment Pathway’ you should follow.
You can find more about how these rules work in our article Pension drawdown rules explained.
A final thought...
Given that so many of us lead such busy lives, you might be tempted just to stash all your pension paperwork in a drawer and only dig it out at retirement. However, it’s essential to get to grips with where your money is invested, as the wrong option could mean a much worse financial outcome at retirement.
It’s also a good idea to weigh up the tax implications of where your retirement savings are, so you can make sure you don’t end up handing over more than you need to the taxman.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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