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Retirement planning made easy
Retirement planning made easy

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5.2 Defined contribution pension

For defined contribution pensions, the options for those aged 55 years or more are:

  • Take up to 25% of the pension pot tax-free.
  • Use the pot to provide a guaranteed income for life through what is known as an ‘annuity’.
  • Have a guaranteed income which provides an income for a set number of years. Some of these products offer a maturity payment which is agreed at the start and can then be used to purchase another retirement product.
  • Leave the non-tax free 75% of your pot invested and then withdraw money as required (known as ‘drawdown’).
  • A combination of the above.
  • Or you could ‘cash in’ the entire pension pot and take it as one lump sum - although if you do this you need to have a clear plan for how you will provide yourself with an income in retirement. An alternative to this is to cash-in part of the pot leaving the rest invested until needed. For both full and part ‘cash-ins’ a quarter of each sum drawn is tax-free and the rest is taxable.

If you do decide to start taking an income from your pension savings, either through drawdown or an annuity, you are restricted on the amount you can save into your defined contribution pension after this point. The maximum you can save is currently £10,000 a year (2023/24).

Also, don’t forget you could simply leave your pension pot completely untouched and allow it to build up further before you draw on it. Clearly this is only an option if you have other sources of income in the interim – for example by continuing to work or by drawing on any non-pension savings.

If you are using drawdown (or periodic cash-ins of a part of your pension pot) you’ll need to ensure that you have enough money to cover however long you live. Without careful planning you could find that your pension savings run out too early.

You can check the government’s estimates on life expectancy provided by the Office for National Statistics (ONS) by following the link below which you should open in a new tab. Remember with life expectancy you may well live longer than the average. For example, the average life expectancy for a woman aged 65 today is 87 years, but she has a 1 in 4 chance of living to 94, and more than a 1 in 20 chance of celebrating her 100th birthday. So it is best to be cautious and go with the higher ages as you might well live beyond the average. Also it is a good idea to review the life expectancy forecasts every few years to check that you are still on track to make sure your pension savings will cover you for the rest of your life.

ONS Life Expectancy Calculator [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip)]

The issue of not having enough money for retirement has been concerning the regulator, the Financial Conduct Authority (FCA) and pension providers. Often those starting retirement take their 25% tax-free cash and then pay little attention to how the remaining amount is invested and whether it will give them enough money to last for the retirement they want. To address this issue four ‘investment pathways’ are now being used by pension providers to help those approaching retirement to select a plan for their pension savings that matches their needs. These pathways are based on the following goals:

  1. You have no plans to touch your pension savings in the next five years
  2. You plan to use your pension savings to set up a guaranteed income (an annuity) within the next five years
  3. You plan to start drawing on your pension savings for long-term income within the next five years
  4. You plan to draw on all your pension savings within the next five years.