Those hitting retirement have a host of options
Making the change from work to retirement is all about choosing the life you want once the demands of a career come to an end.
For the first time in decades you’ll have the freedom to pick where you spend your time, and how, free from the nine-to-five. But the process of arranging your retirement finances in a way to give you the retirement you want takes some careful consideration.
There are now many options for those looking to turn their lifetime’s retirement savings into a retirement income and maximising those choices is the aim for anyone hitting retirement. The right course to take will be specific to you and your circumstances - there can be no hard and fast rules about what’s best and we make no recommendations about what will suit you best.
But, with the help of the specialists in Fidelity’s retirement service, we can lay out the types of decisions you might have to make and some important considerations for those looking to maximise their retirement income.
Wants and needs - and why they are different
Establishing the income you really need in retirement is an important first step in anyone’s retirement planning. We all have spending which is essential - on our housing, bills and food costs for example - and then spending which we could do without if we really needed to.
A common aim in retirement planning is to ensure essential spending is covered as much as possible by income that is guaranteed and protected against inflation. Sources of guaranteed income might include the state pension or Defined Benefit pensions where the income you get is certain. Beyond that you can use money from retirement savings to purchase an annuity which provides guaranteed income (read more on that below).
After essential spending comes desired spending - on things you may want but could do without in a pinch. Gym memberships, regular holidays and eating out might qualify. Spending like this can be covered by income from invested money which is not guaranteed - for example the income generated by investments.
Once you prioritise your spending like this you’ll be in a better place to decide how to generate the income you need, as well as identifying areas you can cut back on if you need to. Get started with our tips to creating a retirement plan.
Annuities and drawdown - getting the best of both
For those with savings held inside pensions - either within personal pensions or workplace schemes - there are two popular methods of turning this money into a regular income: annuities and drawdown.
An annuity is a product that turns pension savings into guaranteed income. The deal is that you hand over a pot of money and an annuity provider will pay an agreed level of income for the rest of your life. Drawdown - sometimes called flexible retirement income - leaves your money invested instead, with an income generated by investment returns, dividends and interest from bonds.
Each method has benefits and drawbacks. Annuities offer income that is guaranteed no matter what markets do so it can be a good way to cover your essential spending needs, but the money you use to purchase an annuity no longer belongs to you. Money invested in drawdown, on the other hand, is still yours but the income you get depends on investment returns, so can fluctuate - it is not guaranteed.
Thankfully, you don’t have to choose one or the other - you can have both. By annuitizing enough to cover essential spending you can invest the remainder of your pension savings via drawdown with an eye on growth, knowing that your costs are covered if you need to let investments recover for a period.
Volatility - holding something in reserve
Before you take the decision to leave some of your pension money invested in drawdown it is important to understand the risks you face from market fluctuations. Investing your money in drawdown means taking the risk that it could lose value. Some people will simply not be comfortable with that risk and so may prefer to consider alternative income options.
If you do rely on drawdown to provide some of your retirement income you need to make sure the income you are taking is sustainable for as long as you need it. Many retirement plans will start with annual withdrawals set at between 4% and 5% of the total fund value but it is vital to reassess withdrawal levels regularly to make sure your pot remains sustainable. If market movements mean that the value of investments has fallen, withdrawing more money from the fund means that it has no chance of recovering those market falls.
That’s why retirement advisers will often suggest holding a portion of your money in cash savings and taking the regular income you need from this reserve in the first instance. Anything from one to three years’ worth of spending is common. With income coming from a cash reserve, and then being replenished from invested money when possible, you can leave invested money untouched if it has fallen in value and be better placed to withstand market ups and downs.
Tax-free cash
From age 55 - many years before most people will actually stop work - current pension rules normally allow as much as 25% of the value of a pension pot to be withdrawn without income tax to pay. It offers a potential cash boost as you begin retirement that can be used however you wish – whether that’s to clear debt, help grown-up children or to pay for a dream holiday home.
With a quarter of your pension pot generally at stake – a pot that’s there to support you for the rest of your life – it’s important to take tax-free cash in a way that suits you best. If you don’t immediately need the money for one-off purchases, it can make sense to use tax-free cash as income in the early years of retirement, giving invested money the chance to grow.
Remember, there’s help available if you’re trying to draw up your own retirement plan but don’t feel confident to do the job. Fidelity’s retirement service has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice based on your personal circumstances and help you select products though this will have a charge. You can call them on 0800 860 0048, Monday to Friday from 9am to 5pm.