It’s a big adjustment to go from earning a regular salary to relying on your pension to pay the bills, fund holidays and enjoy the retirement you’ve been looking forward to.
And there’s often a nagging question in the background: how much can I afford to spend without worrying about running out of money later?
There are several ways to turn your pension savings into an income, but choosing how to take that income also means thinking about how long your money needs to last. You might choose flexible withdrawals, a guaranteed income through an annuity, or a combination of the two.
How much income will I need in retirement?
Before deciding how to take money from your pension, think about what you want your retirement to look like.
Perhaps you’re planning to travel more, take up new hobbies or spend time with family. You might want to help your children financially, make improvements to your home or simply enjoy having more freedom over how you spend your days.
Start by working out what this lifestyle might cost, alongside your regular household expenses.
Your spending is also likely to change throughout retirement. You might spend more in the early years when you’re fit, active and able to do more, then less as you get older. Later on, additional care or support could increase your costs again.
Next, consider what income you’ll already have coming in. This might include:
- Your State Pension
- A defined benefit (final salary) pension
- Rental income or other regular income
- You may also have ISAs, cash savings or other investments that could help fund your retirement.
This will help you work out what you’ll need from your personal pensions and other savings.
How can I turn my pension into an income?
If you have a defined contribution pension, there are several ways to access your savings when you retire.
– Pension drawdown
Flexi-access drawdown allows you to leave your pension invested while taking money from it as and when you need it.
You could arrange regular monthly withdrawals to replace your salary or take occasional lump sums for larger expenses, such as holidays or a new car.
You have flexibility over how much you withdraw, although your pension’s value will continue to rise and fall with investment performance. Taking too much, particularly when markets are falling, could mean your savings run out earlier than expected.
– Buying an annuity
An annuity converts some or all of your pension savings into a guaranteed income, usually for the rest of your life.
You can choose different features, such as an income that increases over time or payments that continue to a spouse or partner after your death. These choices will affect how much income you receive.
An annuity provides certainty, but generally offers less flexibility once it’s been purchased.
– Taking lump sums
You may be able to withdraw money directly from your pension in one or more lump sums without setting up drawdown or buying an annuity.
Usually, 25% of each withdrawal is tax-free and the remaining 75% is taxable as income, subject to your available tax-free allowances.
Taking larger amounts could increase your tax bill and leave less money available for later retirement.
– Combining your options
You don’t necessarily have to choose one approach for your entire pension.
For example, you might use part of your savings to buy an annuity that helps cover your essential living costs, while keeping the remainder invested in drawdown for more flexible spending.
You can also leave money untouched until you need it.
Pension drawdown or annuity: which might suit me?
The main difference is between flexibility and certainty.
With drawdown, you can adjust your withdrawals as your circumstances change. Your remaining pension stays invested, giving it the potential to grow, although its value could also fall.
An annuity gives you a guaranteed income, which can make budgeting easier and remove the worry of your pension income running out. However, you generally can’t change the arrangement once it’s been set up.
Death benefits also differ. Money remaining in drawdown can usually be passed to beneficiaries, subject to the applicable rules and tax treatment. With an annuity, payments after your death will depend on the options selected when you bought it.
The decision will depend on how much income you need, what other financial resources you have and how comfortable you feel with investment risk. As some decisions can be difficult to reverse, an independent financial planner can help you weigh up the options and decide which approach is most appropriate for your circumstances.
How much can I safely withdraw from my pension?
There’s no single withdrawal amount that will be sustainable for everyone.
How long your pension lasts will depend on several things, including how much you withdraw, investment performance, inflation, charges and how many years you spend in retirement.
Taking too much income in the early years could leave you short of money later on, particularly if you’re retiring early and your pension needs to support you for 30 or 40 years.
There’s also the risk of withdrawing money when investment markets are falling. If you’re taking an income from a pension that’s losing value, you could deplete your savings more quickly, leaving less invested to benefit from any subsequent recovery.
How will my pension income be taxed?
You can usually take up to 25% of your defined contribution pension tax-free, subject to the Lump Sum Allowance (LSA) and your individual circumstances.
The remainder will generally be subject to Income Tax when you withdraw it. The way you take your pension can therefore make a difference to the tax you pay.
For example, withdrawing a large sum in a single tax year could push some of your income into a higher tax band. Spreading withdrawals across several years may help manage your tax liability, depending on your circumstances.
You also don’t have to take all your available tax-free cash at once. With some pension arrangements, you can access it gradually as you need it.
Read more: Should I take my tax-free pension lump sum all at once?
The tax treatment of pension withdrawals depends on your individual circumstances and may change in the future.
How can I make my pension income last throughout retirement?
After spending decades building up your pension savings, it can be difficult to start drawing on them. You might worry about running out of money and find yourself putting off holidays, experiences or other plans, even when your finances could comfortably support them.
Having a financial plan can help you give yourself permission to spend.
Cashflow modelling can show how your pension, savings and other income might support your lifestyle throughout retirement. It can also test different scenarios, such as spending more during your early retirement years or experiencing a period of poor investment returns.
Although these projections aren’t guarantees, they can show what you might be able to afford.
Regular reviews are important too. Your investments, spending needs and personal circumstances will change, so the amount you withdraw may need to change with them.
Making your pension work for the retirement you want
At Amber River, our Life Landscaping® approach starts with understanding how you want to spend your retirement, then looks at how your pensions, savings and investments could help fund it.
An independent financial planner can explore your options, use cashflow modelling to test different spending scenarios and help you build a retirement income plan that gives you greater confidence about the years ahead.
Get in touch
If you’re approaching retirement and wondering how to turn your pension savings into a reliable income, the Amber River team can help you explore your options and build a retirement income plan around your goals.
To speak to one of our financial planners, please call 0800 915 0000 or use our contact form to arrange an appointment.
Frequently asked questions
Can I take a monthly income from my pension?
Yes. If your pension offers flexi-access drawdown, you can usually arrange regular monthly payments, much like receiving a salary. Alternatively, an annuity can provide a guaranteed regular income. The options available will depend on your pension arrangement.
Do I have to buy an annuity when I retire?
No. With most defined contribution pensions, you can choose between drawdown, annuities, lump sums or a combination of these options. You can also leave your pension invested until you need it.
Can I combine pension drawdown with an annuity?
Yes. You could use part of your pension to buy an annuity that provides a guaranteed income, while keeping the rest invested in drawdown. This may offer a balance between income certainty and flexibility.
Will I pay tax on my pension income?
Usually, yes. You can generally take up to 25% of your pension tax-free, subject to the applicable allowances, but most other pension withdrawals are taxable as income. How much tax you pay will depend on your total taxable income and individual circumstances.
What happens if my pension runs out?
If you exhaust the money held in pension drawdown, payments from that pot will stop. However, you’ll continue to receive any State Pension, defined benefit pension or lifetime annuity income you’re entitled to. Planning and regularly reviewing withdrawals can help manage this risk.
Can I change how I take my pension income later?
With flexi-access drawdown, you can usually increase, reduce or stop withdrawals, subject to your provider’s terms. You could also choose to buy an annuity later. However, once you’ve purchased most types of lifetime annuity, you generally can’t change your decision.
This is important:
We’ve written this article purely for general educational purposes. It’s not investment advice, or an invitation or inducement for you to invest your money. The information in the article can go out of date over time too – thanks to law and tax rule changes.
Your situation will be unique to you, and that’s why you should always seek personalised advice from a qualified financial adviser before taking any action.
