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.
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 |
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Defined benefit pension |
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Defined contribution pension |
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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.
Investment bonds also allow income to be taken without increasing the client’s immediate income tax bill. Withdrawals from other investments are likely to be taxed. However, it might be preferable to taking pension income for two reasons:
• It might be possible to reduce risk exposure by cashing in higher risk assets such as direct equity investments.
• Unlike pensions, these investments would be included in the estate in the event of the owner’s death.
Investing in property is a valid alternative strategy to market-based investments, particularly if it is income generating as a result of a third party let. The downside is, however, that the property could be difficult to rent and/or sell, which is a particular drawback for those intending to use the value of their own residence.
| Income level | Options at retirement |
Property |
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Lifetime Iis (Lisa) |
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Other Isa |
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Direct equities |
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Bond |
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Building society/bank account |
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Whatever the income source, or more likely mix of sources, most retirees will require it to last for a considerable time and the longer it needs to last, the lower the amount that can be safely withdrawn in each year. It is essential that income sustainability, incorporating all income sources, is regularly monitored and if it looks likely that it will run out, action should be taken. The most obvious option here would be to reduce the level of ongoing income. However, another option might be to delay retirement.
Most pensions will be increased if they are taken later, including the state pension, which offers generous terms for those likely to have better than average longevity. Unfortunately, the individuals who are most likely to need to work longer are the least likely to be able to, since those with higher earnings and greater savings are also likely to be in the best health. That is why private savings are essential – they make working longer a choice, not a necessity.
Fiona Tait is technical director of Intelligent Pensions
Key points
Pensions are the only option specifically designed to provide long-term income in later life.
There are combination products that offer an annuity underpin and drawdown facility within the same plan.
Investment bonds allow income to be taken without increasing the client’s immediate income tax bill.
