Only two in five understand their retirement options – do you?

Only two in five (42%) adults have a clear understanding of their options for taking an income in retirement, according to research from investment platform Hargreaves Lansdown.

Among the over-55s, this proportion increases only slightly (to 45%), despite retirement income decisions being most relevant to this age group.

Here, we explain the various ways you can access your pension and what to consider before making your decision.

Low awareness increases the risk of bad decisions

If you're yet to retire, you'll likely be relying on defined contribution pension schemes to fund your retirement, meaning your income will depend on how much you’ve saved and how you decide to access your savings. 

You can't take money from your pensions until you're at least 55 (rising to 57 in 2028), but you can do so at any point after that.

A lack of awareness of your options for accessing this money could lead to poor decisions, such as buying an annuity that isn't right for you and can't be reversed, or drawing down too much from your pot early in retirement. 

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: 'This can lead to not having enough income, potentially running out of money, or incurring huge tax bills that needn’t have happened. All can have a huge impact on your standard of living, and all are avoidable.'

If you have a defined benefit pension – which pays an income based on how much you earned while you were working – your payments will be guaranteed and you won’t have to face the same decision about how to access your money. 

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How can you access your pension savings?

You can take up to 25% of your pot tax-free, up to a maximum of £268,275 across all your pensions. 

You have several options for turning the rest of the money into a retirement income:

Pension drawdown

Pension drawdown allows you to keep your pension invested, and draw out income as and when you wish. You can take out as much as you want, although this money will be subject to income tax, so you'll need to take that into account.

If you die before the age of 75, your beneficiaries can access any money remaining in your drawdown plan tax-free. If you're over 75 when you die, the money you pass on will be taxed in the same way as income. 

Any money left in your pension or drawdown plan when you die is currently exempt from inheritance tax, but that is set to change in April 2027.

3 key things to remember

• Taking out too much money early in retirement can lead to running out of money entirely.
• Opting for pension drawdown isn’t for the risk-averse – you need to be comfortable with investment volatility. A financial adviser can help you come up with an appropriate investment strategy. 
• Drawdown charges can vary considerably. Opting for a more expensive provider can make an unnecessary dent in your pot. 

Buy an annuity

Annuity sales have risen over the past couple of years, driven by high interest rates, which have boosted annuity rates.

Buying an annuity involves swapping your pension savings for a guaranteed regular income that will last for the rest of your life.

You can have this income increase in line with inflation by buying an index-linked annuity (rather than a level annuity), but payments will start off much lower. 

3 key things to remember

• Once you buy an annuity, it can't be unwound – you're stuck with the product and rate that you arrange at the outset.
• Better rates are available if you're older (or if you're in ill health), so you might decide to hold off buying an annuity until later in retirement.
• There are various types of annuities to choose from, including those that provide an income to your spouse after your death.

Lump sums

You can leave the money in your pension and take out lump sums when you need to. The technical term for this is uncrystallised funds pension lump sums (UFPLS). This just means that you haven't 'crystallised' your pension pot by turning it into an income. 

You can only opt for UFPLS if you haven’t already taken any tax-free cash or income from your pension.

With each lump sum you take, 25% will be tax-free, and the rest is treated as income and taxed in the same way. For example, if you take a £20,000 lump sum, £5,000 of this would be tax-free and £15,000 would be treated as income.

You have the option to take all your money in one go, but this could generate a high income tax bill and increase your risk of running out of money later in retirement.

3 key things to remember

• This can be a holding measure if you haven't yet decided how to access the rest of your pot.
• You can benefit from spreading your 25% tax-free allowance over time to stay on the right side of higher-rate tax bands.
• It's a simple solution for smaller pots where setting up a pension drawdown might not be cost-effective.

Mix and match

It’s worth remembering that you don’t have to commit to a single option for accessing your pensions. You can access different pots in different ways, or use more than one option for accessing the same pot.

For example, you might want to use some of your savings to buy a guaranteed income via an annuity and maintain some flexibility by leaving the rest in drawdown. 

Bear in mind that not all pension schemes offer all options, so you might need to consider transferring to a different scheme to access your money in the way you'd like. 

If you want more information about your different options, over-50s can get a free guidance session through the government's Pension Wise service.