Options for Creating an Income in Retirement

John F. Kennedy once said, "Change is the law of life, and those who look only to the past and present are certain to miss the future." The same holds true for pensions, especially with the pension freedoms introduced in 2015, which expanded the options available for those taking and receiving their retirement income.

Previously, receiving retirement income from your pension was straightforward. You’d contribute monthly to your pension, retire, and then either receive payments from your former employer based on your salary or purchase an annuity that provided a fixed monthly income. While there were some exceptions, this was the norm for most people. Today, however, retirement planning is far more complex.

Since the introduction of the significant aforementioned pension freedoms in 2015, those approaching retirement must now consider which assets they’ll draw on to create their retirement income, the timing for when to start taking this income and the method for how they’ll access these funds.

Handling these choices alone can feel overwhelming, with numerous factors to weigh and decisions to make.

A variety of factors can impact your retirement options…

Firstly, the size of your fund. The total amount accumulated in your pension pot will naturally guide your retirement decisions. However, it’s important to consider more than just your pension. Other assets, such as ISAs, rental properties, or even your home, can provide additional sources of income in retirement. Sometimes, leaving your pension untouched can be more tax-efficient, potentially reducing any inheritance tax liability on your estate although recently proposed changes to pension legislation means additional care needs to be taken with pensions and estate planning.

There are also tax implications. Drawing from your investments without a strategic plan can result in significant tax burdens, which could impact your overall income. Careful planning is essential to create an income stream that minimises your tax liabilities.

Income security is another area you need to be aware of. Assess whether you can tolerate any risk to your retirement income. If your budget will be tight, you may prefer the certainty of a guaranteed income. The idea of a variable income that depends on market fluctuations may not appeal if stability is a priority.

Your financial needs are of paramount importance. Most people wish to retire comfortably, free from financial stress, which is only fair after years of hard work. Others might envisage a simpler lifestyle with fewer expenses. Understanding your desired standard of living will shape your retirement strategy.

Your health is also a vital aspect. As life expectancy increases, health considerations play a crucial role in planning. If you have health issues that could affect your longevity, these should be factored into your decisions to ensure you make the most of your resources.

Lastly, leaving a legacy is very important. While many are content with passing on their home to their children, you might also want to leave part of your investment portfolio to assist them with challenges like buying a house or paying off student debt. If leaving an inheritance is important to you, this should be incorporated into your retirement planning.

Consulting with a retirement professional, such as Reeves Independent, can simplify and speed up the process of evaluating your retirement options.

Some income sources may not be immediately obvious…

Many people approaching retirement tend to focus solely on their pension schemes for income. However, this approach might not be the most effective. Why? Because leveraging other assets could provide income more cost-efficiently or with lower risk.

Here are six potential sources of retirement income.

State pension

Your state pension offers a guaranteed baseline income once you reach the state pension age. With its "triple lock" system, it’s protected against inflation, ensuring steady payments for life. The challenge is when you can start claiming it, as working until 67 or older isn’t appealing to most, who prefer to retire earlier.

Paid work

Transitioning to part-time work or consulting roles can be an attractive option. It eases the shift from full-time employment and provides a supplementary income until your state pension starts.

Investments and savings

Savings in ISAs and other non-pension investments, especially amounts like £40,000 or £50,000 and above, can generate a valuable tax-free income just when you need it most.

Property

Investment properties can provide steady rental income to support your retirement. Even your primary residence can be a source of funds. Leveraging low interest rates to borrow against your home, through an extended mortgage or equity release, can generate income while your pension remains invested. However, changes in regulations may impact the attractiveness of property investment.

Defined Benefit schemes

These traditional final salary schemes offer secure income similar to a state pension but can often be accessed earlier. Depending on your situation, transferring benefits to a private pension might be advantageous, allowing for higher tax-free cash, flexible income options, and the possibility of passing on remaining funds to your family - benefits typically not offered by drawing directly from these schemes.

Money Purchase pension

This type of pension, also known as a Defined Contribution scheme, is central to many retirement plans. It provides the flexibility to start withdrawals from age 55* (or earlier in certain cases involving specific health conditions or protected occupations). There are several strategies to create income from your money purchase scheme, which will be explored further. * increasing to 57 from April 2028

Drawing income from your money purchase pension

Once you turn 55, you now have complete flexibility to access the funds in your money purchase pension. This area has seen the greatest expansion in options since the 2015 pension freedoms were introduced.

Here are the main options and their pros and cons.

Leave your pension untouched 

Keeping your defined contribution pension invested allows your fund to grow over the 20-30 years of your retirement. For instance, if you had £100,000 at age 60 and it grew at an average real rate of 5% annually, it could reach £271,264 by age 80. This approach also offers the advantage of passing the remaining funds to your children free of inheritance tax.

Tax-free lump sum 

You can withdraw up to 25% of your pension as a tax-free lump sum, allowing you to access a significant amount of money without income tax. This can be a tax-efficient way to fund early retirement activities, though taking a large sum upfront can reduce the long-term income from your pension.

Drawdown 

By "crystallising" your pension, you can begin to draw regular payments or take smaller lump sums from your fund while keeping the remaining balance invested. This strategy allows for continued market growth alongside income withdrawals.

Purchase an annuity 

An annuity provides guaranteed income throughout retirement, offering security for those who prioritise stability. However, low annuity rates due to longer life expectancies can make them less attractive. Additionally, annuities often stop payments after death or pay a reduced amount to a spouse, unlike funds left in a drawdown that can be passed to heirs.

Take your entire pension as cash 

You have the option to withdraw your whole pension pot as cash, but be aware that only 25% of this is tax-free. Any amount above this will be subject to income tax and therefore requires appropriate planning .

Combine different strategies 

You don’t have to stick to just one approach. The new pension rules allow you to mix and match these options, tailoring your strategy to your unique needs and circumstances.

Seeking guidance – Reeves Independent can help you

Evaluating these various options for generating retirement income can be challenging. Some choices are irreversible, and your tax liability can significantly differ based on how you structure your income. For these reasons, seeking advice from a pension specialist like Reeves Independent is strongly advised. Reeves can guide you through your options and help create a personalised plan that suits your needs. Schedule a free review today to start your journey towards a brighter, more sustainable future.