Depending on the type of pension scheme you have, you might need to decide how you’re going to turn it into an income when you retire.
But how will you know what to do?
Firstly, find out what type of pension you have
Paperwork from your pension scheme should tell you whether you’re in a defined contribution or a defined benefit scheme. Or you might have a scheme that’s a mix of both, called a hybrid scheme.
Your income options will depend on which type of scheme you have:
| Defined contribution scheme (also called a money purchase pension) |
Defined benefit scheme (also called a final salary pension) |
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Examples of a defined contribution pension scheme include a personal pension or a group personal pension (from your employer). With these schemes, you’ll need to decide how and when you want to start taking your pension. You can usually start from age 55 (rising to age 57 in 2028). How much income you’ll get depends on how much you’ve saved and which of the options you choose (see below). |
This scheme will pay you a guaranteed income for life. Your scheme provider gives you a ‘normal pension age’, which is when you’ll start receiving your money. It might be possible to take your income before then, but the amount your receive will probably be reduced. How much you’ll get depends on your salary when you retire and how long you’ve been a member of the scheme. |
Your options if you have a defined contribution scheme
A defined contribution scheme won’t automatically pay you an income when you retire, so you’re going to have to take some action.
You can start withdrawing your savings from age 55 (rising to age 57 by 2028), and there are different ways to do that. You might choose one of the options below, or a mixture of more than one.
- Withdraw your pension savings as one lump sum or a series of lump sums
You can take your whole pension pot as one lump sum. The first 25% (up to a maximum of £268,275) is tax-free, then you pay income tax on the remainder.
Or you can take a series of lump sums with the first 25% of each one being tax-free (up to the maximum of £268,275).
Taking more than 25% of your pension pot as a lump sum in this way is called an ‘uncrystallised funds pension lump sum’ or UFPLS. Catchy, we know!
Things to consider:- As soon as you take your pension as a lump sum, or when you take the first in a series of lump sums, you’ll trigger the Money Purchase Annual Allowance. This means that if you decide to save into a defined contribution pension again, your annual allowance (the amount of money you can save into a pension each year) will reduce from £60,000 to £10,000.
- You might be able to take more than £268,275 tax-free if you have Lifetime Allowance protection. You’ll have received a certificate from HMRC if you qualify for this.
- Not all pension schemes will allow you to take an ‘uncrystallised funds pension lump sum’.
- Buy a guaranteed income for life
You can turn your pension savings into a guaranteed income for the rest of your life. This is called an annuity. You’ll be paid regardless of what happens to investment markets.
Things to consider:- If you want to leave your annuity to your loved ones when you die, you can add protection. You can ensure a certain amount of income, or a lump sum, is paid to your spouse, partner or other financially dependent person. Choosing this protection will have the effect of reducing the amount of guaranteed income you’ll get each year, but it can be valuable. If you die before age 75, your beneficiary won’t pay any income tax on the income they receive. If you die after age 75, they’ll pay income tax at their normal rate.
- You can’t vary your income – it’s fixed for life. Unless you choose an option to increase it each year in line with inflation, but this can reduce the amount of income you start with.
- You can take a 25% tax-free lump sum (usually up to a maximum of £268,275) immediately before the annuity starts, but not once the annuity has started.
- If you buy an annuity, you won't trigger the Money Purchase Annual Allowance as described in point 1 above. So you can save £60,000 a year into a defined contribution scheme.
- Move your savings into income drawdown
With income drawdown, you leave your pension savings invested and you can usually take an income when you need it.
Things to consider:- When you die, the money left in your fund can be passed to your loved ones. If you die before age 75, your beneficiary won’t pay any income tax on the income they receive. If you die after age 75, they’ll pay income tax at their normal rate.
- Unlike an annuity, there are no guarantees. If your investments perform badly, or if you take too much income, you could run out of money.
- You’re likely to pay ongoing fees and charges for the management of your investments.
- You can decide to buy an annuity with your income drawdown funds at a later date.
- If you move your pension funds into income drawdown, you’ll trigger the Money Purchase Annual Allowance. This means that if you decide to save into a defined contribution pension again, your annual allowance (the amount of money you can save into a pension each year) will reduce from £60,000 to £10,000.
- A combination of the above
You can take your tax-free lump sum out, then buy an annuity with just enough to cover your basic spending needs. Then put the rest of your pension savings into income drawdown so it may continue to grow, and you withdraw it when you need it. Some pension schemes don’t offer all these options so you may need to move your money to another pension scheme first to give you more flexibility. This might incur additional costs.
- Do nothing
If you don’t need your pension savings, you can leave them where they are. There are some benefits to doing this. For example, your savings won’t be subject to inheritance tax if you die. And if you die before age 75, usually your beneficiaries won’t pay income tax when they spend those savings.
- Combine your pensions before making a decision
If you have more than one pension you might want to consider combining them into one place before taking an income. Read our Guide to combining your pension pots for the benefits of doing this, and the things you need to consider.
Your options if you have a defined benefit scheme
Defined benefit schemes pay a guaranteed income for life. You don’t need to make any decisions on how this is paid. But there are some options to consider:
- Take a tax-free lump sum
You can take up to 25% of the value of your pension as a tax-free lump sum (by exchanging some of your pension income for cash), but you may have to wait until the scheme’s usual retirement age before you can do this.
- Take small defined benefit pension pots as cash
You might be able to take the value of your defined benefit scheme as cash if the value is less than £30,000. This is called a trivial commutation lump sum. Or instead you might be able to take up to £10,000 as a ‘small pot’. Under an occupational scheme there is no limit to the number of times you can do this. You’d need to talk to your scheme about these options.
- Transfer your defined benefit pension(s) to a defined contribution pension provider
You might consider converting your defined benefit pension(s) to a defined contribution pension scheme. This can be a good option if:
- You’d like more flexibility over how much income you take each year.
- You want to leave as much money as possible to your loved ones when you die.
If you do this, you need to be aware that you’re giving up valuable guarantees. So if you want to transfer defined benefit scheme benefits over £30,000 to a defined contribution scheme, you’ll have to take financial advice.
Next steps
You’ve got several options when it comes to finding out more or seeking help - Expert advice and guidance (pensionbuddy.co.uk).
We strongly recommend you take advice from an adviser authorised by the Financial Conduct Authority (FCA) before making any big decisions about your pension.
