Retirement Routes: Flexible income

Last week we looked at guaranteed income (or annuities), along with the advantages and things to consider when buying an annuity.

This week, we’re looking at flexible income.

In this blog:

• What is flexible income?
• Advantages of flexible income,
• Considerations before choosing flexible income, and
• Support on your journey

What is flexible income?

Flexible income – or drawdown – is still the most popular retirement income option, according to data from the Financial Conduct Authority (FCA). Flexible income is where you take your money from your pension pot bit by bit.

To do this, you invest your pension in a ‘flexi-access drawdown’ arrangement. You can then take as much or as little income as you like, as often as you like. It’s important to note that you’ll have to decide where to invest the remainder of the pension pot you move into drawdown.

You can usually choose to take up to 25% of your pension pot as a tax-free lump sum when you move some, or all, of your pension pot into drawdown. Any amounts you withdraw after this will be taxable as earnings (in the tax year you take them).

Advantages of flexible income

Total flexibility
One of the great advantages of drawdown is its flexibility. There’s no cap on how much you can withdraw or when you decide to do so. This allows you to tailor your retirement income according to your personal needs and lifestyle. Imagine you’re faced with unexpected expenses, like a home renovation – you can adjust your withdrawals to cover these costs. Also, during years when your expenses are lower, you can decrease the amount you take out, preserving your funds for longer.

Leaving a legacy
Another benefit is the potential for inheritance. If there are funds remaining in your drawdown pot upon your death, these can be transferred to your chosen beneficiaries. Beneficiaries of individuals who pass away:

• before reaching 75 – can usually receive the remaining funds tax-free.
• after the age of 75 – any money they inherit will be taxed at their standard income tax rate – whether they opt to take it as a lump sum or as regular income.

Managing tax
Managing your drawdowns can also lead to tax efficiency. Since the income you withdraw is subject to income tax, it’s wise to think about the following things:

• Be aware of your pension income tax allowance, which is the income threshold before taxes kick in. For the 2024/25 tax year, the standard personal allowance is £12,570.
• Consider the timings of your withdrawals, especially in relation to the tax year that runs from April to April.
• Remember, up to 25% of your pension pot can normally be taken as tax-free cash initially. However, this reduces the amount available for future income.

Changeable in the future
The choice of an adjustable income doesn’t lock you in forever. If your circumstances or preferences change, you have the option to switch to an annuity later – securing a guaranteed income for life.

Growth potential
Even as you begin to withdraw funds, the remainder of your pension continues to be invested within the drawdown scheme, providing an opportunity for growth. It’s important to remember, though, that investments can fall in value as well as rise. The future value of your pension pot depends on how well your investments perform and how much you decide to withdraw over time.

Considerations before choosing a flexible income

Total responsibility
Choosing drawdown means you’re in the driver’s seat – making all the critical decisions on your own unless you seek professional advice. You’ll need to decide how much money to withdraw and the timing of these withdrawals to optimise tax benefits. The task also involves picking the right drawdown product from the wide selection available in the market.

With options varying in terms of fees, flexibility, and investment choices, picking the best value for your needs can be daunting.  But what’s the best way to get help with a difficult subject? Consult an expert. A financial adviser can help you understand your options and decide which would work best for you.

Navigating investment risk
Going down the drawdown route also means facing investment risk head-on. You’ll be selecting where to invest your funds, and there’s always the possibility these investments could decrease in value. Such dips in value might result in lower income levels than initially anticipated, affecting your financial security in retirement.

The risk of running out
Flexible income isn’t guaranteed. The harsh reality is that there’s no guarantee your funds will last throughout your retirement. Ensuring your income remains sustainable requires careful planning.

Tax planning
If you’re considering drawing from your pension while continuing to contribute to a defined contribution (DC) scheme, it’s important to understand the impact on your tax relief. The Annual Allowance is a limit on the maximum pension contributions that can be paid each tax year before a tax charge applies. This is usually £60,000 (2024/25) for most individuals. This allowance includes both yours and your employers’ contributions.

However, initiating withdrawals from your retirement benefits while still contributing to your pension can reduce this allowance to just £10,000 – known as the Money Purchase Annual Allowance (MPAA). This could limit the tax advantages of future retirement savings, highlighting how important financial planning is when thinking about ongoing pension contributions and withdrawals.

Support on your journey

While flexible income offers flexibility and control over your retirement income, it comes with its own set of responsibilities and risks. It’s important to approach these challenges with caution and, where possible, seek professional advice to help navigate the journey. 

Guidance
Pension Potential, a service from Punter Southall, can show you:  

• how long a flexible income could last for you,
• how different levels of income and investment growth could affect this, and
• how flexible income compares with other options, such as annuities.

Advice
Flexible income is a complicated option. You’ll need to decide which provider to choose. There can be big differences between pension providers’ offerings, including charges and how flexile their products are. And you’ll need to choose investments with the aim of keeping your money growing – and this isn’t guaranteed.

Because of this, you might want regulated financial advice. A good financial adviser will aim to get to know you and your circumstances. This will enable them to understand what’s important to you and what you’re trying to achieve with your retirement savings, so they can work with you to help you achieve your retirement vision in an effective and economical way.

Individual financial advice is available through Foster Denovo, the parent company of Secondsight and Aspire to Retire.

>You can contact the team by calling 0330 332 7866, or by emailing advise-me@fosterdenovo.com. Foster Denovo will explain any fees clearly in advance.

You can also find more information on getting guidance and advice on our ‘Help and support’ page.

Join us next week as we look at another retirement route: cash.