The introduction of pension freedoms brought about fundamental changes to the way we can access our pension savings.

Current pension freedom rules mean those aged over 55 (increasing to 57 by 2028) can access their pension income by purchasing an annuity, entering drawdown, or taking a cash amount. There is now much greater flexibility around how you take your benefits from Money Purchase Pension (Defined Contribution) schemes, which includes Self-Invested Personal Pensions (SIPPs).

How pensions can be taken has been dramatically relaxed

Since the rules governing how pensions can be taken have been dramatically relaxed, pension freedoms have given retirees considerable flexibility over how they draw an income or withdraw lump sums from their accumulated retirement savings. There is no doubt the pension freedoms have been hugely popular.

Deciding what to do with your pension pot is one of the most important decisions you will make for your future. What are your options to consider?

Leave your pension pot untouched for now and take the money later

It’s up to you when you take your money. You might have reached the normal retirement date under the scheme or received a pack from your pension provider, but that doesn’t mean you have to take the money now. If you delay taking your pension until a later date, your pot continues to grow tax-free, potentially providing more income once you access it. If you do not take your money, you should check the investments and charges under the contract.

Receive a guaranteed income (annuity)

You can use your whole pension pot, or part of it, to buy an annuity. It typically gives you a regular and guaranteed income. You can normally withdraw up to a quarter (25%) of your pot as a one-off tax-free lump sum, then convert the rest into an annuity, providing a taxable income for life. Some older policies may allow you to take more than 25% as tax-free cash. There are different lifetime annuity options and features to choose from that affect how much income you would get.

Receive an adjustable income (flexi-access drawdown)

With this option, you can normally take up to 25% (a quarter) of your pension pot, or of the amount you allocate for drawdown, as a tax-free lump sum. The remainder of the funds would stay invested, with the aim of maintaining capital growth to provide you with taxable income at a later date. You set the income you want, though this might be adjusted periodically depending on the performance of your investments. Unlike with a lifetime annuity, your income isn’t guaranteed for life, so you need to manage your investments carefully.

Take cash in lump sums

How much and when you take your money is up to you. You can use your existing pension pot to take cash as and when you need it and leave the rest untouched, where it can continue to grow tax-free. For each cash withdrawal, normally the first 25% (quarter) is tax-free, and the rest counts as taxable income. There might be charges each time you make a cash withdrawal and/or limits on how many withdrawals you can make each year. With this option, your pension pot isn’t re-invested into new funds specifically chosen to pay you a regular income, and it won’t provide for a dependent after you die. There are also tax implications to consider.

Cash in your whole pot in one go

You can do this, but there are certain things you need to think about. There are clear tax implications from withdrawing all of your money from a pension. Taking your whole pot as cash could mean you end up with a large tax bill – for most people, it will be more tax-efficient to use one of the other options. Cashing in your pension pot will not give you a secure retirement income.

Mix your options

You don’t have to choose one option: you can mix them over time or over your total pot when deciding how to access your pension. You can mix and match as you like and take cash and income at different times to suit your needs. You can also keep saving into a pension if you wish and get tax relief up to age 75.

Financial situation at retirement

The way you draw an income from your pension is likely to be largely determined by your financial situation at retirement. Will you, for example, still be paying off your mortgage, or do you have any other significant debts? What other income sources, aside from the State Pension, will you have at your disposal?

While an annuity can offer you the security of a guaranteed regular income, a drawdown plan gives you the chance to grow your pension and overall wealth during retirement. The latter route is likely to suit those with a stronger appetite for risk, as any significant market swings could potentially cause serious damage to your pension savings.

Think carefully before making any choices

The pension flexibilities may have given retirees more options, but they're also very complicated, and it's important to think carefully before making any choices that you can't undo in the future. Withdrawing unsustainable sums from your pensions could also dramatically increase the risk of you running out of money in your retirement.

Please note: This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

The content of this article was accurate at the time of writing. Whilst information is considered to be true and correct at the date of publication, changes in circumstances, regulation, and legislation after the time of publication may impact on the accuracy of the article.

The information in this article is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change and tax implications will be based on your individual circumstances.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by interest rates at the time you take your benefits.

Accessing pension benefits early may impact on levels of retirement income and your entitlement to certain means-tested benefits and is not suitable for everyone. You should seek advice to understand your options at retirement.

FP2022-425