It pays to be prepared as retirement nears – be prepared for change and the inevitable decision-making. The Money Advice Service recommends that from about two years out, you should start thinking about your options and planning for the choices you’ll need to make. Consider getting professional advice because there are decisions that will shape your income and lifestyle for the rest of your life.
1 – Work out your likely retirement income. Your annual pension statements, or pre-retirement information from your pension provider or providers, will give you an estimate of the kind of pension income you can expect in retirement. You’ll need to request a forecast of your likely State Pension entitlement, and you should also take account of any income you might have from other savings, investments or assets.
2 – Shop around to get the best pension income for you. The most important thing you can do in the run-up to retirement is to shop around to find the best pension income – both the right kind of income, and the highest income of that type that’s available on the market. Most people buy a lifetime annuity with their pension savings, which means it’s a decision that affects their income for the rest of their life. It pays to get it right – shopping around can boost your income by 20% or more, and once you’ve bought a lifetime annuity you generally can’t change it.
3- Decide which kind of pension income is right for you. Most people need to know they have a minimum level of guaranteed income for life, so they purchase a lifetime annuity with their pension savings. Be aware that a fixed pension income will decline in value over time as prices rise. Consider ways of coping with inflation, such as an annuity that pays a rising income, phased pensions, or saving part of your income now to draw on in retirement.
There are other features to consider when choosing a lifetime annuity, depending on your preferences. For example, do you want your pension to provide for your dependants after you die? Do you want to link your income to the ups and downs of underlying financial investments? You may want to consider income options other than lifetime annuities, such as fixed-term annuities or income drawdown.
4 – Don’t miss out on an enhanced annuity if you have health problems. In most instances – such as buying life assurance – declaring any health problems can reduce your benefits and increase your costs. But the reverse applies when it comes to buying an annuity. If you have health problems or an unhealthy lifestyle, you may be entitled to a higher pension income. Many people who are entitled miss out, so make sure to check your position!
Decide whether to take some of your pension as a tax-free cash lump sum. You can take a portion of your pension as a cash lump sum when you retire. For most people, a quarter of their pension savings can be taken as a tax-free payment in this way.
Most people take their full tax-free entitlement, but this has a knock-on effect on the income you’ll get in retirement, so consider carefully what you can afford and how you’ll use any lump-sum payment.
5 – Decide when to retire and take your pension. The most likely reason to postpone your retirement date is to boost the pension income you’ll get. There are no absolute guarantees, but in general if you retire early you’ll get a lower pension income and if you delay retirement you’ll get a higher pension income. You can’t take the State Pension early, but if you defer it you’ll get either a boost to your weekly entitlement or a lump sum payment.
6 – Consider ways to boost your pension if you need to. With retirement nearing, the scope for making major adjustments to your likely retirement income is limited. But there are still things you can do if you want to make the most of the time that remains before you retire. Two key ways of boosting your pension are to pay more into it – to take advantage of as much tax relief as possible – or to defer the date you start taking an income.
7 – Don’t take risks with the pension savings you’ve built up. While there’s limited scope to make a guaranteed boost to your pension savings in the months before retirement, there are potential risks to the value of your savings to be aware of. In general, in the years leading up to retirement you should already have made sure that the way your pension is invested changed, to reduce the weighting of higher-risk assets such as shares. You should check with your pension provider to make sure your pension savings are invested appropriately.
8 – Clear your debts. You should normally try to start your retirement as free of debt as possible. Your income is likely to go down, so any fixed repayments will start to take up a bigger share of it. Many people use their pension tax-free cash lump sum to clear as many debts as possible. However, in many defined-benefit (salary-related) pension schemes, taking a lump-sum payment can be expensive in terms of the amount of pension income you must give up in return – in these cases it might be better value not to take the lump sum and to prioritise repaying your debts out of the higher pension income.
9 – Be ready for changes in your day-to-day budgeting. You’ll probably need to get used to a different pattern of income and spending when you retire. You’re likely to have less money to live on. Work-related costs will fall, and you may have paid off many of your debts. But your spending may go up in other areas, such as leisure, healthcare and, if you’ll be at home more, things like heating. To prepare yourself for these changes, it’s a good idea to draw up a budget – a record of where your income comes from and how you spend it – and to think ahead to how it might change in the years ahead.
10 – Seek professional advice. The whole area of pension income options and choices is complex. Making mistakes with your own pension arrangements can turn out to be very costly in the long term and life-changing in unwelcome ways. Seeking reliable independent advice should be an early move in your pre-retirement planning.