Over time you build up a ‘pot’ of money (a pension fund). When you retire you arrange payments through an insurance company, or in some cases through your pension provider. This type of personal pension scheme is called ‘defined contribution’.
The 3 basic steps when arranging your retirement income are:
Decide when you want to retire.
Decide how you want to be paid.
Shop around for the best deal on a regular payment (buying an ‘annuity’).
When to retire
Generally, the older you are when you take your pension the higher the payments because your life expectancy is shorter.
However, there are some schemes that let you take larger payments while keeping your pension fund invested.
How you want to be paid
When you’re close to retirement you have to decide how you want your pension to be paid.
You can usually take part of it as a lump sum and the rest as regular payments. This will depend on the arrangement you have with your pension provider.
These can be monthly, quarterly, half-yearly or annually.
You’ll have to pay Income tax on your pension payments.
Taking smaller pension pots as lump sums
You must be at least 60 to take smaller pension pots as lump sums.
If you have £30,000 or less in one or more pensions, you can usually take the whole amount as a lump sum (sometimes called a ‘trivial commutation’).
To qualify for a trivial commutation:
- you must have all your pension savings in all schemes valued by your pension providers on the same day no more than 3 months before the first payment
- all payments must be paid within 12 months
You can also take up to 3 personal or stakeholder pensions of less than £10,000 as cash payments, no matter how much you get from other pensions. For workplace pensions, you should check with your pension provider if this is possible.
In some cases, when you’re expected to live less than a year, you can take your whole fund as a lump sum. Check with your pension provider. If you’re under 75 you won’t have to pay tax on it unless your pension funds are worth more than the lifetime allowance.
If you’re over 75 you pay 55% tax on payments because of serious illness.
Arranging regular pension payments
You can choose to get regular payments from your pension pot by buying an annuity, or take payments while keeping it invested.
Buying an annuity
If you’re in a defined contribution pension scheme you can buy an annuity (a retirement income). This is a contract between you and an insurance company. You instruct your pension provider to hand over all or part of your pension fund to an insurance company and they give you regular payments until you die.
The amount of the regular pension payments under your annuity depends on how long the insurance company expects you to live and how many years they’ll have to pay you.
To calculate your annuity they could take into account:
- your age
- your gender
- the size of your pension fund
- interest rates
- your health (sometimes)
You don’t have to buy your annuity from your pension provider. There are different kinds of annuity and you can shop around to get the best deal.
Keeping your pension fund invested
You can take payments from your pension fund while keeping it invested. This is called a ‘drawdown pension’. Check with your provider if they offer this. You might have to pay tax if you continue paying into your pension fund. There are 2 types of drawdown pension - capped and flexible.
With capped drawdown your pension provider calculates a maximum amount you can take out every year. This limit will be reviewed every 3 years while you’re under 75 and every year once you’re over 75.
With flexible drawdown you can take out as much as you want. You also have the option to take the whole pension pot in one go. There’s no limit to the amount you can take.
To get a flexible drawdown pension you must prove to your pension provider that you already have a minimum yearly pension income of at least £12,000 from other sources, eg an annuity or a workplace pension.
Talk to your pension provider to find out what the best option is for you.
Find out more on Pension Wise about how you can take your money, tax and charges. You can also book an appointment to speak to someone.