Visualise it, and make it happen
There are a lot of options available and it may seem bewildering… but don’t worry, we’re here to help. Thanks to your employer’s partnership with Aspire to Retire, you’ve got access to lots of information and support to help you achieve your retirement aspirations.
Your options for taking your benefits
Reaping the rewards of all your working and saving
Workplace pensions can be defined contribution (DC) or defined benefit (DB). Although DC is more common nowadays, you may have both types of workplace pension. Here we’ll look at what kind of benefits you’ve got and the ways you can take them.
Important note: Beware of scams
When taking your benefits, you need to be aware of pension scams – in the past the average pension scam victim has lost £75,000.
Know what to look out for and how to protect yourself – tips for being scam-proof.
1 | Defined contribution (DC) pensions
A DC pension builds up from:
- your contributions, plus your employer’s contributions if it’s a workplace pension, and
- growth from your chosen investments over the long term.
You can currently start to take benefits from a DC pension from age 55 – but the longer you leave your pension savings, the more retirement income you’re likely to get, as it has more time to build up from contributions and investments. (Note: the minimum age you can take your DC pension will increase to 57 from 2028 for most people).
You can start taking benefits even if you’re still working, but it’s important to know the way you take your pension benefits may reduce your tax-free allowance for future pension contributions – we cover this in ‘Understand tax’.
This is where you use the money in your pension pot to buy a policy called a ‘lifetime annuity’, which pays you a guaranteed income for the rest of your life.
You can normally take one-quarter of your pension pot as tax-free cash first if you want to, although this will make your income smaller.
There’s a wide choice of lifetime annuities providing different types of income, for example:
- an income that increases, either at a fixed annual rate or in line with inflation
- a level income that starts at a higher level than an increasing annuity, but doesn’t increase
- an income that will be paid to your husband, wife or civil partner if you die before them
- potentially, a higher income for people with health issues who aren’t expected to live as long as healthy people.
You can also buy a short-term annuity that guarantees you income only for a certain period. This could be worth considering if you don’t want to commit to a lifetime annuity yet.
You pay income tax on the income from your annuity in the same way as earned income. For most people, this means your annuity is taxed at your highest rate of income tax for the year through Pay As You Earn (PAYE). The annuity provider usually takes the tax off your pension and pays you the net (after tax) amount, similar to the way an employer pays their employees through a PAYE payroll. If you’re a non-taxpayer you can usually ask your provider to pay your annuity gross (without tax deductions).
Once you’ve started to receive your annuity you can’t change it during the payment period. It’s very important to consider your options carefully, and compare quotes from all the available annuity providers, before you make a final decision.
To find out more about guaranteed income, read this freedom factor blog.
This is where you take your money from your pension pot bit by bit.
To do this, you invest your pension pot in a ‘flexi-access drawdown’ arrangement. You can then take as much or as little income as you like, as often as you like.
If you opt for this, you:
- can normally take up to one-quarter of your pension pot as tax-free cash before leaving the rest invested, if you want to
- pay income tax, at your highest marginal rate for the year, on the income you take out
- should be careful not to take out too much in the earlier years, or you could risk running out of money altogether
- keep on investing your pension pot to try and make it grow, but investment growth can’t be guaranteed (and the value of your remaining pension pot will usually be linked to investments which can fall in value as well as rise).
You don’t have to stick with adjustable income for the rest of your life. It might make sense to consider a different option later down the line (i.e. annuity).
To find out more about reviewing your drawdown, read this freedom factor blog.
You can take your pension pot as cash. One-quarter is tax-free (as long as you have enough lifetime allowance).
You can either take one single cash amount, or a number of smaller cash amounts over several months or years.
Each time you take money out, one-quarter is tax-free (again, as long as you have enough lifetime allowance) and you pay income tax on the remaining three-quarters.
Some people think about taking some cash as soon they reach the minimum age for taking benefits (currently 55) and then carry on saving for their retirement. But it’s important to know that taking cash like this can reduce your tax-free allowance for future pension contributions. Go to the ‘Understand tax’ section for more details.
To find out more about taking cash, read this freedom factor blog.
You might be able to combine two or more of these options. For example, take tax-free cash, buy a guaranteed income with some of your pension pot and leave the rest invested to use as adjustable income in later life.
To find out more about mixing your options, read this freedom factor blog.
Tips when considering your options
1. Check with your provider.
Not all DC pension providers offer all the retirement options we’ve set out here. They may have additional rules or conditions, such as a minimum amount of cash you’re allowed to take, or a certain size pension pot for taking an adjustable income. To get the options you want you may have to transfer your benefits out to another pension. Pension transfers may carry risks or disadvantages, so it’s important to check carefully before you transfer a pension. You should consider taking advice from an expert. Go to ‘Getting support’ for more about this.
2. Beware of scams.
The number of fraudsters trying to persuade people to transfer their retirement savings so they can get at the money is increasing, and the statistics are alarming – in the past the average pension scam victim has lost £75,000. Know what to look out for and how to protect yourself – tips for being scam-proof.
2 | Defined benefit (DB) pensions
- part of your salary, and
- how long you built up benefits in the scheme.
(Your DB pension may also be called a ‘final salary’ or ‘career average’ pension, depending on what kind of DB pension it is.)
Your main option from a DB pension is an income paid for the rest of your life. It will increase each year and the increases depend on the rules of your scheme. Here are some key facts about DB pensions.
- You normally start to take your pension income when you reach your scheme’s normal retirement age.
- Depending on the rules of your scheme you may be able to take your pension income earlier, possibly from age 55 – but if you do, your pension is likely to be reduced because it’s being paid early and could be paid for longer.
- You may be able to delay taking your pension income until after your scheme’s normal retirement age. Your pension might be increased if you do this, as it could potentially be paid for a shorter time.
- You can usually take some of your benefits as tax-free cash, although this could make your pension smaller. How taking tax-free cash affects your DB pension varies from scheme to scheme. Not all DB schemes reduce pension for cash – some have an automatic tax-free cash option that doesn’t reduce the pension.
If you want to use your DB pension in other ways – such as taking an adjustable income – you’ll have to turn it into a DC pension pot by transferring your benefits out to another pension. This is a serious step you should think carefully about before taking. You should certainly consider taking advice. In fact, you may be required to take financial advice before your scheme trustees will allow you to transfer. Go to ‘Getting support’ for more about this.
3 | Taking small pensions as cash
If you have a small pension, you may be able to take it all as cash – although you could pay tax on most of it.
It may not be in your best interests to take all your pension as cash even if it’s small, especially if it’s a DB pension which could give you a potentially valuable income with increases for the rest of your life.
The rules on taking small pensions as cash are complicated and there are different rules for DC and DB pensions.
More information on taking small pensions
You can usually take small DC pension pots worth up to £10,000 each as cash. One-quarter will be tax-free and three-quarters will be taxable.
- If they are workplace pensions and are ‘trust-based’ (meaning they are managed by a board of trustees) there’s no limit on the number of pensions you can take as cash.
- If they are personal or stakeholder pensions – which can also be offered by employers as workplace pensions – you can take up to three as cash.
Taking any of your small DC pensions as cash won’t:
- affect your other pensions, or
- reduce your tax-free allowance for making future DC pension contributions.
You can usually take DB small pensions worth up to £10,000 each as cash. One-quarter will be tax-free and three-quarters will be taxable. As all DB pensions are ‘trust-based’ workplace pensions (managed by a board of trustees) there’s no limit on the number you can take as cash.
Taking any of your small DB pensions as cash won’t:
- affect your other pensions, or
- reduce your tax-free allowance for making future DC pension contributions.
It may also be possible for you to take all your pension benefits, including your DB pension, as cash if the scheme rules allow. To be able to do this the total value of your pension benefits, including the DB pension, must be £30,000 or less. This includes any pensions you’re already receiving and DC pension pots, but not your State Pension.
- If you haven’t yet started taking income from any of your pensions, one-quarter of the cash will be tax-free and the remaining three-quarters will be taxable.
- If you’ve started taking income from any of your pensions, the whole cash amount of the pension in payment will be taxable.
Need to talk through this? Go to ‘Getting support’ to find someone to help you.
Find out more about small pensions here
4 | Ill-health early retirement
You can’t usually take pension benefits before age 55. The exception is ill-health. If you can no longer do your job due to an accident or illness and you can provide medical evidence, you may be able to take the benefits from your workplace pension earlier than 55. Or, if you’re over 55, you may be able to take them before normal retirement age without an early-retirement reduction (if it’s a DB pension). What you can take from your pension depends on your scheme’s rules. Check with your provider.
5 | Your State Pension
Your State Pension is based on your National Insurance record and date of birth.
- You build up State Pension based on your National Insurance record. Your National Insurance record shows the number of years you paid National Insurance contributions or received National Insurance credits (which are paid to carers and people on certain kinds of benefits).
- To get the new full State Pension, you need at least 35 ‘qualifying’ years on your National Insurance record, if you don’t have a record before April 2016.
- You can claim State Pension from your State Pension Age (which is based on your date of birth).
Does your State Pension forecast show you’ll get less than the full amount?
If your forecast says you’re due to get less than the full amount of State Pension, check your National Insurance record. You might find you’ve got less than the 35 years of full-rate contributions you need for the full State Pension, if you don’t have a record before April 2016.
1. Why might you have less than the full amount of National Insurance contributions?
Maybe you have some gaps in your working record – for example, you took time out to raise a family, for education or travel.
Or, your pension scheme was ‘contracted out’ of part of the State Pension. Contracting out stopped in 2012 for DC schemes and 2016 for DB schemes.
Contracting out is complicated and this is only a high-level summary.
While you were contracted out, you didn’t build up the earnings-related part of the State Pension (which existed in various forms from 1961 until 2016). As a result you may be entitled to less State Pension than if you’d always built up earnings-related State Pension. The idea is that your contracted-out workplace pension compensates for the State Pension you didn’t build up.
The way contracting out worked depends on whether it was done through:
- a workplace pension, or
- a personal pension.
If you contracted out through a workplace pension, you would have paid lower-rate National Insurance contributions. If it was a DB scheme, it promised to pay you at least as much as you would have had from the State Pension – a promise backed by your employer. But if it was a DC pension, the difference between the lower-rate and full-rate National Insurance contributions was paid into your pension and its value may not make up for the State Pension benefits you would have built up if you hadn’t been contracted out.
If you contracted out through a personal pension – either privately or through an employer – you paid the full rate of National Insurance but the government diverted some of your National Insurance into your personal pension. So you have a personal pension pot called ‘protected rights’ that you can use like any other DC pension pot when you retire. But, there’s still a risk its value may not make up for the State Pension benefits you would have built up if you hadn’t been contracted out.
2. You might be able to pay more National Insurance contributions
You might be able to pay voluntary National Insurance contributions to top up your State Pension. You normally have to do this within six years of the year where you have a gap.
This is another complicated area. The cost of paying voluntary National Insurance varies and it won’t always increase your State Pension, so you’ll need to find out if you’ll benefit first. Contact the government’s Future Pension Centre.
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Understand Tax 