When funding retirement isn’t as easy as swapping a salary for a pension

Faith Archer

by , Personal Finance Journalist and Blogger

at Much More With Less

25 Mar 2024 /  

A PensionBee customer sitting on an armchair.

This article was last updated on 08/04/2024

Juggling income in retirement is rarely as easy as swapping a salary for a pension.

In theory, it sounds so simple: pay into a pension while working, to provide an income when your salary stops. In practice, it can be more complicated if you have multiple pensions that kick in at different ages, plus other investments.

My husband and I, for example, are lucky enough to have reached our 50s with a host of different workplace and personal pensions. Plus, we’re both eligible for the State Pension. We’re not alone – today’s average workers will have 11 different jobs in their lifetime, according to the Department for Work and Pensions (DWP). Each one could come with a different pension pot attached, although you can choose to combine them for easier management. Plus, pensions aren’t the only way to fund retirement. We also have some cash savings, investments in Individual Savings Accounts (ISAs) and rent from a small buy-to-let property.

A combination of different pensions and investments makes managing money in retirement trickier. But it can also give you more flexibility around when you retire and how you tap into your savings. With careful planning, it may be possible to retire a bit earlier, trim your tax bills and, most importantly, avoid running out of money.

Choices about when to retire

As I tear my hair out over retirement planning, I sometimes wish our pension arrangements were as simple as hitting one long-awaited day when our retirement starts. In practice, our mishmash of pensions have start dates strung out over an entire decade - unless we choose to defer any of them.

Currently, the State Pension age is 66, but it’s getting older - in fact it rises to 67 in 2028 and may even rise again beyond that. My husband and I will only qualify after turning 67, and younger people face waiting even longer. If you’re not sure what your State Pension age will be, use the PensionBee State Pension Age Calculator to see when you can begin drawing this government benefit.

You can typically get your hands on personal pensions around a decade earlier, from the age of 55, rising to 57 from 2028. With workplace pensions, it’ll depend on the rules of the individual scheme. Personally, I have:

  • a couple of pensions I can access from 2029 (when I’m 58);
  • a workplace pension that starts from 2036 (when I’m 65); and
  • my State Pension, which I can access from 2038 (when I’m 67).

Meanwhile my husband, who’s a bit older, has a couple of pensions that he can tap into from 2028, four due to start in 2033, and another due in 2035 alongside his State Pension.

Our mixed bag of pensions and investments means we may be able to afford to retire before State Pension age. We could potentially make ends meet before then by either:

  • withdrawing the 25% tax-free lump sum from some or all of our personal and workplace pension pots;
  • starting to take regular withdrawals or ad-hoc withdrawals as and when you need; or
  • running down other savings and investments.

This flexibility can be a major benefit if you want to go part-time or stop working earlier. Or if you’re forced to do so for example due to job loss, ill health or caring responsibilities.

Choices about how to use our pension money

Our jumble of pensions also widens our options when it comes to managing our retirement income.

Regular income from State Pension and defined benefit pensions

My husband and I are both on track to amass the 35 years’ worth of National Insurance contributions needed for a full new State Pension. If we were retiring today, we’d each get £221.20, which adds up to just over £23,000 a year between us. The State Pension should increase every April, but who knows what this will look like when we retire in 2038!

Fortunately for my husband, three of his pensions are defined benefit schemes racked up from his first jobs. Defined benefit pensions, often known as ‘final salary schemes’, have the advantage that they pay a guaranteed pension income for the rest of your life. You don’t have to worry about what the stock market is doing, or whether you might run out of money in retirement. Two schemes start when my husband reaches 60, with another at 65, and all three are due to increase each year in line with inflation based on the Retail Price Index (RPI).

The combination of defined benefit pensions and the State Pension means we’ll have a reliable bedrock of rising income to cover our essential household bills. Many cheers! Our buy-to-let property will also hopefully provide regular income but there’s always the risk of unexpected bills and time between tenants with no rent coming in.

Transforming defined contribution pension pots into income

The State Pension and defined benefit pensions are the easy ones - they pay a regular income. You might have to decide whether to delay their start dates, and whether or not to take 25% of any defined benefit pension as a tax-free lump sum, but otherwise: job done.

With defined contribution pensions, which the majority of modern personal and workplace pensions are, you end up with a pot of money, and then have to decide how to turn that into income. Imagine your employer dumping a bunch of cash on your desk, and saying ‘here, use that to get by for the next few decades’. That’s a defined contribution pension! The size of any defined contribution pension pot will depend on how much you (and any employer) have paid in and how your investments have performed.

After reaching retirement, you can choose whether to:

  • delay taking your pension pot and leave it invested;
  • withdraw the whole lot, of which 25% is tax-free;
  • use the money to buy an annuity, which pays a guaranteed income for as long as you live or for a fixed term. You also have the option of taking 25% of your pension pot tax-free prior to purchasing an annuity;
  • leave the money invested and take a flexible income via pension drawdown. This also gives you the option of taking 25% of your pension pot tax-free;
  • leave the money invested and take it as a number of lump sums. 25% of each withdrawal will be tax-free and the rest is taxable; or
  • you can use a mix of all of the above options.

In our case, knowing we have some guaranteed income from the defined benefit and State Pensions means we’re willing to take more risk, in the hope of greater returns, with our defined contribution pension money.

I’m up for moving our defined contribution pensions into what’s called ‘pension drawdown’, and then withdrawing money as and when needed. With pension drawdown, your money stays invested in the stock market, which historically has delivered higher growth over the long term than sticking it in a savings account. However, it also means our balance will bounce up and down with stock market movements and there are some risks. If we withdraw too much, especially after share prices fall, we could run out of money. To avoid this, we’ll need to keep a decent cushion of cash savings, which we can use to top up our income if markets plummet, rather than being forced to sell drawdown investments at a bad time when they are worth less.

Choices affecting our tax bills

Just to throw another bunch of decisions into the mix, the way you access your pension money can affect your tax bills. With pensions, only the first 25% can be withdrawn tax-free - the rest is taxable as income. Any regular income from defined benefit and State Pensions? You’re likely to pay income tax if you earn more than the tax-free Personal Allowance, currently £12,570 for tax year 2024/25, and get hit by higher rate income tax on anything over £55,270 for tax year 2024/25.

With defined contribution pensions, you have more flexibility about how much money you take and when. If you withdraw a large lump sum, and it pushes your income into a higher tax band, you could end up with a bigger tax bill than if you made smaller withdrawals over several years. If you keep working after retirement age, you might choose to withdraw less from your defined contribution pensions while earning, and then bump up withdrawals afterwards. No point being taxed on money you don’t need, especially when keeping it invested can provide an opportunity for further growth.

You may also be able to trim your income tax bill in retirement if you use money from ISAs to top up your pension income, as withdrawals from ISAs are totally tax-free.

If Inheritance Tax is likely to be an issue, spending ISA money first can make sense, because ISAs do get counted for Inheritance Tax purposes, while pensions don’t. So in our situation, if we retire before 67, we’re intending to use ISA money to plug some of the gaps before our State Pensions kick in, because any money left in our defined contribution pensions when we die can pass to our kids free from Inheritance Tax.

Where to get help

Thinking about which pension and ISA money to use and when makes my head hurt, even though I’m a Personal Finance Journalist. If you want to get help, the first port of call, if you’re over 50, is to book a free appointment with Pension Wise. This government-backed service provides guidance on your pension options. You can hear all about my appointment with Pension Wise over on PensionBee’s YouTube.

However, if you want specific suggestions for your personal circumstances, you’ll need to pay for financial advice. Ask around for recommendations or find a qualified local Independent Financial Adviser (IFA) via Unbiased.co.uk or VouchedFor.co.uk. We asked an IFA to plug our figures into a cash flow model, to get an estimate of when we could afford to retire. You can also browse PensionBee’s new retirement hub to learn how to make your retirement dreams a reality as you prepare and adjust for life in retirement.

Faith Archer is a Personal Finance Journalist and Money Blogger at Much More With Less.

Risk warning

As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.

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