A mix 'n' match retirement

Pensions are the most obvious source of income in retirement, after all that is what they are designed to do, but for those lucky enough to have built up other savings there are good reasons why pensions should in fact be the last source of income taken. 

Here we consider the options that might be available to individuals who want to reduce their working hours and need to replace some or all of their earned income with another source.

As stated above, pensions are the only option specifically designed to provide long-term income in later life. Part of this design is that the tax treatment pensions rewards savers for making contributions and for keeping their money invested. When a saver chooses to access their pension benefits they will – with the exception of the pension commencement lump sum (PCLS) – be taxed.

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In addition, lump sum death benefits remain outside the estate for inheritance tax and may be paid tax-free if the member dies before the age of 75, all of which provides an incentive not to spend the pension fund if other assets are available.

Most individuals will receive at least some state pension – up to £159.55 per week for those reaching state pension age in the year 2017-2018 and who have a full national insurance contribution (NIC) record. The major advantages of the state pension are that the income level is guaranteed for life and it will be fully index-linked.

It therefore acts as a good underpin to cover essential spending, but will be unlikely to match replacement income requirements for anyone with average earnings or more. 

For those with private pension savings the biggest decision might well be how to take their income and over what period. This is largely prescribed by the rules under defined benefits schemes, but the income is guaranteed by the scheme. Under defined contributions there is a lot more flexibility. However, income will be dependent on investment returns. This can be mitigated to some extent by the use of third-way products, which fall into one of two categories:

•    Income drawdown products with additional investment guarantees.

•    Annuity-based products with investment and/or income flexibility.

There are also combination products, which offer an annuity underpin and drawdown facility within the same plan. The use of these options is highly individualistic and should really only be considered with financial advice.


Income level

Options at retirement

State pension

  • Initial income based on NIC contributions
  • Future increases decided annually by government
  • High level of guarantee
  • Not available until state pension age
  • Can be delayed in return for increases pension


Defined benefit pension

  • Initial income based on accrual rate, length of service and final salary
  • Increases in payment in line with scheme rules
  • Income in payment guaranteed so long as scheme is solvent
  • Usually paid at NRA
  • Can be taken early at reduced value
  • May be possible to defer and continue to accrue further benefits
  • Tax-free lump sum might be offered via commutation or separate accrual

Defined contribution pension

  • Fund value based on contributions and investment returns
  • Initial income unlimited up to fund value at access/retirement
  • Future income (if not fully encashed) dependent on investment returns unless secured via annuity or other guarantee
  • Can be taken any time from age 55
  • Option to commute up to 25 per cent for tax-free lump sum
  • Option to continue contributions after accessing fund
  • Income may be paid via direct withdrawal (drawdown), annuity or combination plan

Non-pension assets

Non-pension assets are less favourably treated than pensions from a taxation point of view, with the exception of individual savings plans (Isas) from which encashments may be taken free of tax providing certain conditions are met. In the case of a lifetime Isa (Lisa) the conditions exclude making withdrawals before the age of 60 unless it is for the first-time purchase of a property, or in cases of extreme ill health. Most other Isas allow complete flexibility in terms of access, but there are some with conditions relating to the time over which money must remain invested.

This ability to withdraw income tax-free makes Isa savings ideal for providing income in the early years of retirement, where the client might still have earned income and/or may be taking higher levels of income than when they become less active.