This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
You may have already spent years putting money aside into a pension. Yet how, exactly, do you eventually use it to generate an income in retirement? It isn’t the same as living off cash savings since pension pots are typically invested in assets such as stocks and bonds, which carry higher investment risk but also more growth potential. In 2020-21, moreover, you cannot start taking money out of your pension pot(s) until you are at least 55 years old – whereas cash savings and capital in an ISA can be accessed much earlier.
One of the most popular ways to generate a retirement income is via income drawdown. Briefly, this involves taking some of the capital out of your pension pot – e.g. monthly – to cover your living costs, whilst keeping the rest invested. In this article, our financial planning team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire offer a short guide on how pension drawdown works in 2020. We hope you find this content useful. If you’d like to speak to an independent financial adviser, then you can reach us via:
T: 01282 772938
Pension drawdown: an overview
In 2020-21, most people are allowed to start accessing their defined contribution pension(s) from age 55. At this point, you can also withdraw up to 25% of the value of your pot(s) without incurring a tax charge (although some older pensions might allow you to withdraw a bit more). For some, taking some or all of the 25% tax-free sum makes sense. For others, this runs the risk of disproportionately affecting the size of your pension; in the worst-case scenario, possibly leading to you running out of money later in retirement. Make sure you consult an independent financial adviser, therefore, if you are considering this option.
Since 2015, the “Flexi-Access Drawdown” rules remove any restrictions on how much income you can withdraw on the remaining savings in your pension (although this will be subject to tax). The amount you might withdraw each year will depend on a range of factors, such as:
- How your investments perform. If, for instance, they have a particularly difficult year (e.g. during the pandemic-induced stock market crash earlier in 2020) then you might need to withdraw less to avoid excessively eroding the value of your pension pot.
- How much tax you’ll pay. In 2020-21 pension income is subject to income tax – much like a salary is. Assuming no retirement income from other sources, you can withdraw up to £12,500 tax-free. After that, the usual bands apply (e.g. 20% on the next £37,500).
- Your estate plan. If you are not planning on passing your remaining pension savings to loved ones after you die, then perhaps you can afford to withdraw a bit more. Otherwise, you may wish to factor your spending plans into your estate planning.
Continuing to save whilst withdrawing
One important pension rule to bear in mind in 2020-21 concerns the Money Purchase Annual Allowance (MPAA). Normally, you can contribute up to £40,000 per tax year into your pension pot(s) or up to 100% of your earnings (whichever is lower). However, when you start drawing more than 25% from your pension pot the MPAA is triggered, reducing your annual allowance to £4,000. So, if you are planning to continue working whilst also taking money from your pension, make sure you speak to an independent financial adviser first. After all, once the MPAA rules are triggered, there is no going back to your previous annual allowance.
Income drawdown isn’t the only way to leverage a pension pot for a retirement income – nor is it always the best solution for everyone. The main alternative to this approach is to buy an annuity – i.e. a financial product which provides a guaranteed income throughout retirement. This can be a particularly attractive option for people who are not willing to take on much investment risk in their retirement, and who want stable/predictable monthly income each month.
Buying an annuity is a big decision, however. Once you purchase it and the “cool off period” has expired, you cannot change your mind. Annuities also often provide a lower income compared to income drawdown (barring years of poor investment performance), which might affect your quality of life in retirement. Also, bear in mind that many annuities cannot be passed down to loved ones as an inheritance (although some new ones can).
Annuities can be a good choice for some people depending on factors such as your financial goals, your appetite for investment risk, your health, your age and the size of your retirement fund. Again, the best course usually is to speak with an experienced financial adviser to help you weigh the pros and cons of different income options in retirement, to find the best route for your unique financial objectives and situation.
If you are interested in starting a conversation about your own financial plan or pension then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938