How to manage your finances when living on retirement income

How to manage your finances when living on retirement income

 · 8 min read

Age UK says 2.1 million pensioners live in poverty. When approaching retirement, you must manage your finances as efficiently and effectively as possible. There are various ways to draw down your pension pot, and planning ahead can give you a certainty of income as you move into retirement.

  • Faced with a reduced income in retirement, planning and managing your finances as efficiently as possible is crucial. For many people, the focus will be on pension assets and how to maximise income in later life.
  • In recent years we have seen a loosening of pension fund regulations giving more options and control to members.
  • Whether looking to take your tax-free cash entitlement, move into drawdown, buy an annuity, or delay taking your pension income, there is much to consider.
  • It is imperative that you take professional financial advice as you approach retirement to identify the best way forward for your situation. If you make the wrong decision, there may be no going back!
  • How to manage your finances when living on retirement income: FAQs

    • Do I need to take my tax-free lump sum in one go?

      No. You can make several withdrawals over a period of your choice to use up your tax-free lump sum entitlement. As these funds are not eligible for income tax, this can create significant savings.

    • Do I have to take my pension at the earliest retirement date?

      No. You can delay the receipt of private and state pension income, which should, in theory, increase payments when you decide to start withdrawing funds.

    • What happens to my workplace pension fund after my death?

      Most workplace pension schemes will pay out a lump sum of between two and four times your salary. If you die under 75, this lump sum is tax-free. Most workplace pension schemes also payout a taxable survivor’s pension to the deceased’s spouse, civil partner or dependent child.

    • What happens to my personal pension fund after my death?

      Usually, your pension fund assets will be free of inheritance tax on your death. While the trustees will consider your wishes, ultimately, they will decide the beneficiaries of your pension fund assets.

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    For the vast majority of us, moving into retirement can often involve a significant reduction in monthly income. While there are ways and means of budgeting for a reduced income, for many people, the key to a comfortable retirement is managing their pension savings to maximise their income. There are various ways to access your retirement savings, often with tax incentives to consider.

    Different types of pension fund

    There are two types of pension funds: defined benefit (final salary pension) and defined contributions (money purchase pension).

    Defined benefit pension scheme

    As defined benefit schemes tend to be more expensive, many have been wound down, and new schemes tend to be defined contributions. The pension paid from a defined benefit scheme is based on membership of the scheme, duration of employment, and your salary on retirement. Traditionally, pension income will increase in line with inflation so that you retain your relative spending power.

    Defined contribution pension scheme

    A defined contribution pension scheme is one where your contributions and those from your employer are invested. Upon retirement, the funds are either used to purchase an annuity or enter a drawdown period. Personal pensions also come under the defined contribution pension scheme umbrella. The rate of income will depend on the prevailing market rates, and there is no connection to your employment or final salary.

    When can you access your pension pot?

    While it will depend upon the terms and conditions of the pension fund, usually, you should be able to access your pension fund from age 55. This will increase to 57 in 2028 as the government looks to introduce a range of changes to pension regulations. This compares favourably when looking at state pensions, where the state pension age is currently 66 for men and women. This figure will gradually rise from May 2026, creating two different private and state pension payment scenarios.

    Managing your retirement income

    There are several options to consider when you are eligible to access your retirement pot. They will differ depending on the type of pension fund/

    Withdraw the maximum tax-free lump sum

    Under current pension regulations, you can withdraw up to 25% of your pension fund assets when you reach retirement age. This element is free of any taxation, although you would pay tax on additional withdrawals over the 25% limit. While the remaining funds will be used for future income, the detail would depend on the type of pension scheme:

    • Defined benefit scheme - residual income will be based on your final salary
    • Defined contribution scheme - residual income will be based on market rates

    While many people take advantage of the lump sum payment tax relief and delay further withdrawals, there are other options. For example, you may be able to invest your tax-free lump sum into a tax-efficient vehicle such as an ISA or a more general investment fund focused on the stock market. Your investment horizon and the degree of risk will dictate which options are worth considering. It is not advisable to proceed without taking financial advice.

    Maximise your monthly income

    If you decide not to use the tax-free lump sum facility, there will be more funds available for future monthly income. As above, the income level would depend upon the type of pension scheme. If you haven't fully utilised your tax-free lump sum allowance, any future payments up to the maximum lump-sum amount will be tax-free.

    As you approach retirement, it is essential to take guidance from an independent financial adviser who will consider your financial scenario and all available options. In addition, using a pension calculator would give you a helpful insight into your potential income and breakdown.

    Has pension drawdown replaced annuity purchase?

    If you have a defined benefit pension scheme, your income is fixed when you decide to start receiving payments. With a defined contribution pension scheme, the situation is slightly different as there are two main options.

    Purchase an annuity

    In the past, defined contribution pension schemes were obliged to acquire an annuity. This occurred on the commencement of income from the scheme. The open market purchase of an annuity guarantees a level of income (often adjusted for inflation) for the rest of the member's life. However, as annuity rates fell, the government introduced a regulation change.

    While those who prefer a guaranteed income level can still acquire annuities, and there are various types, this is not obligatory.

    Pension income drawdown

    One other option for those with a defined contribution pension scheme is to retain funds within the scheme and drawdown regularly or as and when required. If we assume your lump-sum tax-free allowance has been utilised. All withdrawals would be added to any additional income and taxed at the appropriate rate. Some people find it helpful to delay drawdown to maximise their investment returns. However, it is essential to take financial advice.

    Working while receiving your pension

    Many people assume that once you begin taking income from your pension fund, this is the end of your working life. Not necessarily!

    Legally, there is no set retirement age in the UK, so you can work as long as you wish. Therefore, you may have multiple sources of income, such as a private pension income, plus your state pension and employment income. Whether or not you are working and receiving income from a personal pension scheme (or a state pension in later life) won't impact the payments made from your pension scheme. However, there may well be tax implications.

    If you are working while receiving pension income, the two payments will be combined to create your annual income for tax purposes. It may well be that the combination will take you over the tax threshold or lead to an increase in income tax.

    Is your pension protected?

    Thankfully, while the UK has one of the most active financial services industries globally, there is also significant regulatory cover for both workplace and personal pension schemes. There are two central regulators to consider about pension schemes:

    The Pension Regulator (TPR)

    The TPR is in charge of regulating occupational pension schemes provided by employers for their employees. These can take the form of:

    • Defined benefit schemes, otherwise known as final salary schemes
    • Defined contribution schemes, otherwise known as money purchase schemes
    • Hybrid schemes, a scheme structured specifically for particular employees (e.g. directors)

    This regulatory cover takes in:

    • Scheme trustees
    • Employers
    • Pension specialists
    • Business advisers

    The Financial Conduct Authority (FCA)

    The all-encompassing FCA, the chief regulator for the UK financial services industry, is also involved in pension fund regulations. The FCA has regulatory responsibilities covering those who provide:

    • Personal pensions
    • Stakeholder personal pensions
    • Self-invested personal pensions
    • Workplace group personal pensions

    When you consider that pension income will be vitally important in your later years, it is reassuring for retirees to see the level of regulatory protection available.

    Pension compensation schemes

    There are two specific compensation schemes which cover defined benefit pension schemes and defined contribution pension schemes:-

    Pension Protection Fund (PPF)

    The PPF will pay compensation to members of eligible defined benefit pension schemes on insolvency or fraudulent activity. The fund is generally used to top up where there are insufficient assets to cover workplace pension scheme liabilities.

    Financial Services Compensation Scheme (FSCS)

    The FSCS is a last resort scheme when a financial services firm cannot pay claims made against it. The scheme covers financial companies authorised by the Financial Conduct Authority (FCA) in the event of failure, fraud, etc. While covering pension claims, the scheme is also available for claims relating to:

    • Banks and building societies
    • Credit unions
    • Mortgages
    • Insurance
    • Investments
    • PPI
    • Debt management

    If you have been the victim of fraud or your financial adviser has gone out of business, costing you money, you should take the appropriate advice. All may not be lost, and you may be eligible for compensation, but you need to act quickly.

    Pensions and Lifetime Savings Association

    An additional trade body, known as the Pensions and Lifetime Savings Association, brings together those operating in the pensions industry to raise standards and share best practice.

    Retirement planning is the key

    The vast majority of people will be dependent on private and state pension income in their later years. Consequently, it is vital to plan your retirement finances well before your retirement day. This may involve reducing your investments' risk/reward ratio and switching into cash or nearer cash assets. Alternatively, you may retain funds within your pension scheme and take on a short, medium or long-term investment horizon. 

    Whatever you decide, you must take financial advice every step of the way and consider all pension options for your circumstances.

    Mark Benson
    Mark Benson
    Mark joined Age Group in 2020 and has over 10 years’ experience specialising in writing around property, finance, and investment subjects.
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