If you think you’ve got it made with a £1 million pension pot, think again. It may not be enough to pay for the type of retirement you want
One million pounds sounds like a lot of money, but it may not stretch very far when it comes to providing retirement income. A 65-year-old investor in good health using their £1 million pension pot to buy an annuity – an insurance contract, which pays a guaranteed income for life – could expect to receive around £45,000. However, if they wanted additional features such as protection against inflation and a pension for a surviving spouse, they would struggle to get a pension of much more than £21,000*.
The £1 million figure is key when it comes to pensions because it is the current ‘lifetime allowance’, the amount you can take out of a pension without triggering an extra tax charge of up to 55%. It applies to all the pensions you have, with the exception of your state pension.
The lifetime allowance is designed to increase each year, in line with the Consumer Prices Index (CPI), starting in April 2018. Even so, many investors may be relieved to learn that there are several things they can do to improve their retirement income without exceeding the lifetime allowance.
Consolidate your pensions
A good starting point is to amalgamate your pensions into one large pot. Carl Drummond, Senior Wealth Planner, says: “This can help to make your pensions easier – and sometimes cheaper – to manage, with just one set of paperwork to handle. But it is vital to check that, by transferring your pension, you will not lose a valuable guarantee or incur expensive penalties. Particular care should be taken with defined benefit, or final salary, pensions, as you may lose more than you gain by transferring.”
Most investors are now choosing to put their pensions into ‘drawdown’, enabling them to take money as and when they like. It also leaves the pension fund invested, with the potential to continue growing.
However, it is sensible to put money into investment schemes other than pensions, especially if you are nearing the lifetime allowance. However good the tax relief on your pension is, there is no point in investing further money if you are going to pay up to 55% tax on the benefits.
Money taken from a pension in drawdown can be combined with cash from other types of investment, enabling the investor to choose the most tax efficient way to generate an income. This might include tax efficient investments such as ISAs and investment bonds, and using their annual Capital Gains Tax allowance to take cash tax free from investments that otherwise offer no tax protection.
Keep on working
Many people are also choosing to continue working past their normal retirement age on a part-time basis, rather than taking full retirement. “This helps to supplement their retirement income and, if they have sufficient income, to continue saving. It also provides social interaction and structure to their lives – something that many people who have busy and fulfilling careers find hard to give up,” says Drummond.
Provided you have sufficient money to live on now, you could also increase your eventual retirement income by deferring your state pension. The amount you receive, based on your National Insurance contributions, increases by 1% for every nine weeks you delay or just under 5.9% for every full year. Based on the full new state pension, which provides £159.55 a week or £8,296.60 a year, you would get an extra £479 a year by deferring for just one year. This amount will then usually increase each year, in line with the CPI.
Buy an annuity
Few investors opt to buy an annuity with their pension funds these days. “Annuities don’t really offer very good value for money at the moment, and once you have bought one there is no going back,” Drummond says. “If you die a few months, or even a few weeks, after buying an annuity, the insurance company will usually get to keep the money.”
However, for those investors that want the security of the guaranteed income provided by an annuity, it is essential to make sure they get the best possible deal. Research by the Financial Conduct Authority, the City regulator, found that eight out of 10 people benefit by shopping around and choosing to buy their annuity from a different provider to the one that ran their pension. There is one exception: if your pension includes a guaranteed annuity rate, or GAR, that was fixed when you first started investing, it may provide a bigger annuity income than you could get by switching to another provider.
Investors with serious medical conditions, or lifestyle habits that could limit their lifespan, may be eligible for an impaired or enhanced annuity. This type of contract pays a higher rate of income to purchasers who smoke, or who have a condition such as diabetes, high blood pressure, cancer or kidney failure. “Buying an impaired life annuity can make a difference to the amount of income you receive,” says Drummond. “One of my clients receives more than double the income he could expect if he were in good health.”