Posted on by Liam
If you either have or are thinking of saving into a pension plan you are probably wondering how much retirement income you can expect from your pension pot. So what's the answer?
Under the new pension rules that came into effect in April 2015 you can take now 25% of your pension as a tax free lump sum and as much of the remaining pot as you like as lump sums, but these are taxed as income. In fact, you can treat your pension a bit like a bank account, withdrawing adhoc amounts but where 25% of it is tax-free while the remainder is taxed at your marginal income tax rate. But one thing I must point out is that when the new pension freedoms came into effect pension schemes were not compelled to provide access to them. I cover this in more detail at the end of this article. If your existing personal pension provider does not allow you to access your pension, as per the new pension rules, you can transfer your pension to a provider who will let you. I look at the best SIPPS and pensions for this later in the article as well.
In any event, cashing in your pension is not tax efficient and you will also then need to generate an income from a now smaller pot of money as a result of the taxation. So let's assume that you want to use your pension pot to produce an income.
How much will my pension be?
Here is a fantastic pension pot calculator* which allows you to enter a few details and will instantly tell you how much income you can expect from your pension pot but also whether you are on track for the retirement you want. Plus it can tell you what the impact will be of increasing your monthly pension contributions. Best of all its absolutely FREE! I used it to find out how much my pension will be.
Once you have done that, there are a few other things to consider.....
Will you want to take a tax free cash sum from your pension savings?
Ordinarily you are entitled to take a tax free cash lump sum, from your pension before taking an income. You can take up to 25% of the total fund value but obviously this will reduce the income you receive when buying an annuity (which is a guaranteed income stream in exchange for a capital lump sum) or taking an income via what is known as income drawdown. There is no hard and fast rule whether it's more beneficial to take a cash sum or not, it depends on your individual circumstances. The cash sum is tax free whereas any income payments you receive will be taxed.
With a pension pot of £100,000 a maximum tax free cash lump sum of £25,000 can be taken leaving £75,000 to produce an income.
What type of income do you want from your pension pot?
Details of your pension pot options under the new pension rules are explained here. Ultimately if you want to use your pension pot to generate an income you can use income drawdown (see later), purchase an annuity or a combination of both. If you are unsure what to do then seek the help of a qualified financial adviser. If you don't already have a financial adviser you can trust then you can find a reputable one here.
One advantage of income drawdown is that it gives you greater flexibility over your retirement income and also allows you to keep your pension pot invested so that it can grow, along with your income (although neither is guaranteed). I cover drawdown in more detail later. While annuities are less attractive than they were post the Budget 2014 some people still prefer the security of a guaranteed income stream.
When purchasing an annuity there are a number of different options regarding conditions attached to the payments. For instance payments could be guaranteed for a number of years, increase over time or be payable to a spouse following your demise.
The following examples give you an idea of how these conditions would affect your payments.
- A person aged 65 could currently receive an annual annuity income of £3,400 from £100,000 purchase price, which would increase by the Retail Price Index and be guaranteed for 5 years. The annual income from this annuity is £2,400 less than a level annuity.
What age can I retire?
The age at which you want to start receiving an income makes a massive difference to the amount of income you will receive.
- A male aged 65 could currently receive an annual annuity income of around £5,800 (gross) from a £100,000 purchase price. This income would increase to around £6,800 if aged 70 at time of purchase. These examples are based on a single life, level income with no guarantee.
But for a more personal estimate of potential annuity income this annuity comparison tool is useful.
Do you currently have any health issues?
If you smoke, suffer from ill health or currently take any prescribed medication then you may be able to increase your retirement income by purchasing an enhanced or impaired life annuity. The level of annuity income will depend on your individual circumstances. Interestingly Hargreaves Lansdown has launched an enhanced annuity calculator* which, although not covering every insurer, will give you an indication of the potential uplift in retirement income.
If you want an annuity then decide how you want your income paid?
How you want your income paid can affect, marginally, the income you receive. If you choose to receive your first payment immediately on purchase of your annuity then your income will be slightly lower than if your first payment was 6 or 12 months later.
What annuity provider should I choose?
The amount of your annuity income will differ depending on the annuity provider you choose. Even amongst the top 'best buy' providers there can be a difference of hundreds of pounds each year in the amount of income they will provide. So shop around using the aforementioned annuity calculator.
Is there an alternative to buying an annuity on retirement?
Yes, you could leave your pension pot invested and still receive an income using what is known as income drawdown, this would provide an income now and leave the decision on purchasing an annuity until later. This could be a possible approach for someone moving to part-time employment and who just needs a top-up income rather than annuitising their entire pension pot.
There is a drawback, however, as your pension pot remains invested and therefore could go down in value. If your investment underperforms then you would be left with a much smaller pension pot when/if you eventually want to purchase an annuity or draw further lump sums from your pension pot. For a number of reasons, primarily costs, income drawdown is not considered a viable option for those with pension investments under £100,000 although this is dropping.
So how much income can you draw from income drawdown? Under what is known as capped drawdown there are a number of rules surrounding the level of income that can be drawn which include a maximum amount as well as regular reviews. The calculations of the maximum income are complex but here is a handy drawdown calculator which does the job for you. But to give you a guide a man of 65 can draw a maximum of £8,700 a year initially, subject to ongoing review, from a £100,000 drawdown pension pot (assuming all that £100,000 is being used for income generation).
But there is another option known as flexible drawdown. Under flexible drawdown you can withdraw as little or as much income from your pension fund, as you choose, as and when you need it. When it was first announced flexible drawdown was only available to those with £12,000 secure pension income already. However, since April 2015 this entry level rule has been removed and capped and flexible income drawdown have been superseded by flexible access drawdown to simplify things.
Best Pension & SIPP
Whether you are planning to save for retirement or want to cash in your pension there are a number things to consider before making your product choice. Think of a personal pension like a car. What makes the car go is what's under the bonnet and the fuel you put in it - not the bodywork. So a pension product pulls together everything into a neat package. The array of pensions may seem pretty mind boggling but the good news is that they are now much cheaper and more flexible than ever. A SIPP (a self invested personal pension) used to be only suitable for those with large pension pots but this is no longer the case as competition has driven down SIPP charges. And it is costs which are one of the most important factors when choosing a SIPP. So I have produced a roundup of The best & cheapest SIPPs – low cost DIY pensions.
Hopefully, the above has given an idea of the level of income a £100,000 pension pot can provide. However, you need to be aware that annuity rates are always changing, therefore the above figures should only be used as a guide. Also, I strongly recommend seeking the advice of an independent financial adviser.