When you’re planning for retirement, it’s crucial to understand what flexibility your pension offers, as this could significantly affect your income strategy in retirement.

Defined contribution pensions (also known as money purchase plans), are generally considered to be the most flexible type of pension. That’s because when you reach the age of 55 (rising to 57 from 2028) you can usually do as you wish with your retirement savings. For example, you may decide to take a regular income from your pension while keeping the remainder of your retirement savings invested, swap your pension savings for a guaranteed income for life by using it to buy an annuity, or you might want to take a mix-and-match approach and use a combination of both these options. 

While the majority of pension schemes are defined contribution plans, some are defined benefit or final salary schemes, which provide a guaranteed income in retirement. This type is  typically considered the ‘gold standard’ of pensions, as you’ll have certainty over your retirement income and it will usually rise in line with inflation, but they are less flexible than defined contribution pensions.

If you’re thinking about getting professional financial advice, you can find a local financial adviser on VouchedFor or Unbiased.

Alternatively, if you’re looking for somewhere to start, we’ve partnered with 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 1,000 reviews on VouchedFor, the review site for financial advisors.

Here, we answer your questions when it comes to pension flexibility, and explain what you need to know before you dip into your retirement savings.

What are my options at retirement?

Following the introduction of pension freedoms in April 2015, you have a wide range of options when it comes to accessing your defined contribution pension at retirement.. If you’ve been enrolled into a workplace pension scheme, you’ll most likely be in a defined contribution plan, but check with your employer if you’re unsure. Personal pensions, such as self-invested personal pensions (SIPPs), are also defined contribution plans. 

You can take up to 25% of your pension as a tax-free cash lump sum, with further withdrawals taxed. A popular option is to take an income from your pension via a flexi-access drawdown plan, which allows you to keep their pension pot invested and withdraw money as needed. The remainder of your pension continues to grow tax-free, and you have complete control over how much you take as an income. These flexible features can enable you to tax-efficiently plan for your retirement. For example, you could take a smaller income to avoid being pushed into a higher rate tax bracket. You can also change your income level whenever you wish. 

Gary Smith, financial planning partner at wealth manager Evelyn Partners, said: “You can take smaller lump sums of less than 25% of the pot, of which 25% will be tax free but 75% will be taxable. But you will then trigger the Money Purchase Annual Allowance, which means you can only contribute £10,000 a year going forwards rather than £60,000.

“In a drawdown account, you can choose investments according to whether you want to target more growth for the pot or more stability and certainty.”

Read more in our article Your pension options at retirement and How much tax will I pay when I withdraw my pension?

Buying an annuity

Another option is to use some or all of your retirement savings to buy an annuity with your defined contribution pension. An annuity provides a guaranteed income for life or a specified period and offers income security. Alternatively, you could use part of your pension savings to buy an annuity to cover essential spending (mortgage, and household bills, for example), while leaving the remainder invested. You may also choose greater income flexibility with a drawdown plan in early retirement, for example, and buy an annuity for a secure income later on. Read more in our guide Annuities Explained

Smith said: “In terms of flexibility, many people don’t realise that using a combination of options is possible. For example, you could take your 25% lump sum, use part of the remainder to buy an annuity and leave the rest invested in drawdown.”

You can continue paying into a pension and receiving tax relief on your contributions until age 75 (read more below about continuing to work while taking your pension). 

Smith added: “Finally, there is also the option of cashing in a pot in full, and this is typically only a good idea for small pots that aren’t important for one’s future retirement income, as you will be taxed on 75% of the pot at your marginal tax rate. It is sometimes possible to cash in small pots without triggering the MPAA”.

Read more about this particular allowance in our guide What is the Money Purchase Annual Allowance? and learn more about cashing in small pensions in our article Cashing in small pensions: what you need to know.

How flexible are defined benefit pensions?

If you have a defined benefit pension scheme, such as final salary or career average schemes in the public sector, your options are more limited, although you’ll usually benefit from a valuable guaranteed income in retirement.

The majority of defined benefit pensions have a retirement age of 65, so you typically won’t be able to receive any retirement income from your pension before this age, unless for example, you are diagnosed with a serious illness. You also don’t have the option of buying an annuity or entering into a flexi-drawdown plan. Instead, the amount you receive at retirement is typically based on a proportion of your final year’s salary, multiplied by the number of years you’ve belonged to the scheme.

However, you can usually take a tax-free cash lump sum upfront from a defined pension scheme, often up to 25% of the value of your pension pot. Some schemes also offer the option to trade part of the regular income for a larger tax-free lump sum at the start of retirement. 

Read more about defined benefit pensions and how they work in our guides What is a defined benefit pension and How do public sector pensions work?

How much money can I take from my pension at age 55?

As mentioned, you can usually withdraw up to 25% of their pension pot tax-free from a defined contribution pension from this age. However, it is generally unwise to take out your entire pension pot, as the remaining portion will be subject to income tax. Alternatively, the money can be left invested, allowing for future growth, and it will be free from inheritance tax if you pass away before the age of 75 (read more about this below). 

Bear in mind that taking money from your pension before you need it could affect not only your retirement income, but also the amount of tax you’ll pay, and any benefits you receive. You can find out more in our articles Four big risks of dipping into your pension and Should I take my tax-free cash at age 55? 

If you have a defined benefit pension scheme, as mentioned, you can’t usually withdraw money at age 55, unless you’re seriously ill. The scheme sets your retirement date, or when you can take pension benefits, which will typically be later than age 55 (usually 65). Depending on the rules, it may be possible to take your pension income early, although you are likely to receive a lower income as the pension may have to pay out for a longer time period. However, if you have a defined benefit pension worth no more than £30,000 (or up to three small pots worth up to this combined), rules allow you to take this money as a lump sum from age 55 or over. This is under what are known as ‘trivial commutation’ rules. 

It’s important to understand the rules of any particular pension you have, before making any decisions regarding withdrawals. Seeking advice from a professional financial advisor can help you to choose the right option options for you based on your personal circumstances and retirement goals.

Get your free no-obligation pension consultation

If you’re considering getting professional financial advice, Fidelius is offering Rest Less members a free pension consultation. It’s a chance to have an independent financial advisor give an unbiased assessment of your retirement savings. Fidelius is rated 4.7/5 from over 1,000 reviews on VouchedFor. Capital at risk.

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The State Pension typically forms the bedrock of most people’s retirement plans, but you are unable to claim this until you reach the government’s retirement age – currently, this is age 66 for both men and women. The amount you will receive depends on your National Insurance Contribution (NIC) record, but you can increase your entitlement by 5.8% a year for life for every year you defer. Read more in our articles How the State Pension works and Eight reasons you might decide to defer your pension.

Can I take my pension and still work?

Yes, you can take your pension (whether defined contribution or defined benefit) and continue working as long as you like while using your pension to supplement your income. You may want to reduce your hours, go part-time, or search for other employment opportunities, for example, before you stop working for good. Read more in our complete guides Can I take my pension and still work? and How can I phase my retirement? 

Your pension will not be affected by any income you earn from continuing to work. Beware, though, that delaying taking your defined benefit pension may increase the amount you eventually receive, as many providers increase the income you’ll receive for each year you delay. Beware, though, that taking your pension while earning an income means you’ll potentially lose a greater proportion of your pension to tax. Boosting your earnings with money from your pension may also affect your entitlement to certain benefits.

Can I pass on my pension when I die?

What happens to your pension when you die depends on the type of pension you have, whether you’ve started taking an income, and how old you are when you pass away. 

For defined contribution pensions, if you die before the age of 75, you can usually pass on your pension tax-free to nominated beneficiaries. You can nominate who you want your pension to go to by asking your provider for an ‘expression of wishes’ form. Find out more about these in our article What is a pension expression of wishes?

If you haven’t yet accessed your pension by the time you die, your beneficiaries can take it as a lump sum if they want to. If you were already drawing an income from it, they can receive tax-free withdrawals from the remaining fund. However, if you die over 75, while your pension transfers tax-free, beneficiaries pay income tax on withdrawals at their marginal rate, as you would have. 

For defined benefit pensions, schemes usually pay a lump sum to beneficiaries if you die before retirement age, typically amounting to two to three times your salary, but sometimes more. After retirement age, they must provide a spousal income, typically around 50% of yours. Some offer children’s benefits too, but income usually stops after a spouse’s death.

Find out more in our guide What happens to my pension when I die?

Is my pension flexible enough?

Most of us have saved long and hard to build a pension fund, and it’s essential to make the right choices to give yourself the greatest chance of a comfortable retirement.  

You may have a number of big decisions to make as you approach retirement. For example, if you have a defined benefit scheme, you may be wondering if you should transfer your pension to a defined contribution scheme to make it easier to access your cash and give you more flexibility in retirement. However, it’s extremely important to take professional financial advice if you’re considering transferring a final salary scheme, as you may be giving up valuable guarantees. Read more in our guide Should I transfer my final salary pension? 

If you’ve several defined contribution pension pots, or all of the options outlined above are not offered by your scheme, you can transfer your pension savings to another pension scheme to access the flexibilities elsewhere. This can make the process of managing your retirement savings simpler, and you might be able to reduce the charges you pay too. However, always make sure  this is the right option for you, and that you’re not giving up any valuable guarantees by moving your savings to a different plan. You can find out more about this in our guide Should I consolidate my pensions?

A financial advisor can help you to understand your particular pension’s rules and flexibility, and ensure you make the right decisions for your financial future.

If you’re thinking about getting professional financial advice, you can find a local financial adviser on VouchedFor or Unbiased.

Alternatively, if you’re looking for somewhere to start, we’ve partnered with 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 1,000 reviews on VouchedFor, the review site for financial advisors.

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