Which pension pot should I use first?
I have a defined benefit (DB) and defined contribution (DC) pension with ex-employers and will be 55 in September this year.
I would like to make the most of my personal yearly income tax allowance while also leaving some of my pension funds untouched in the hope that future annuity or drawdown figures will improve.
Is there any advantage of using the DC over the DB or vice versa? Should I consider transferring my DB pension to DC one to use as drawdown income as I do not require a spouse pension or life cover from the plan?
Tom Selby, AJ Bell Senior Analyst says:
Your first port of call should be to think about your retirement income priorities. For example, do you want a secure income every month, or would you prefer more flexibility and the opportunity for your money to grow (albeit with the risk, particularly in the short-term, that it may go down as well as up in value)?
Is the personal allowance (£12,500 in the 2020/21 tax year) enough to cover your spending needs, or will you need more than this? Do you have the time and inclination to manage your fund in retirement?
All these questions and more will help you decide whether taking an income through drawdown or buying an annuity, or a combination of the two, is right for you. It should also help guide any decision to access a defined benefit pension.
It is unlikely your defined benefit pension will be available at its full value from age 55. Most DB schemes have a ‘normal pension age’ – usually 60 or 65 – at which point you should be able to receive your full retirement income entitlement.
It may be possible to get your DB pension earlier, but the income will be reduced at a rate determined by the scheme.
One thing to consider is that once you access your DB pension, there is no going back. This is not the case with defined contribution, where you have a range of options including taking your tax-free cash only, ad-hoc withdrawals or a regular stream of income which you can stop and start any time.
Both DC and DB pension income is taxed in the same way as earned income, so from this perspective there should be no difference in terms of which you draw on first.
It’s also worth noting there is no guarantee that annuity rates will improve, while the amount you can sustainably take as an income through drawdown will depend on a variety of factors including your age, health and the performance of your investments.
Remember as well that both DC and DB pensions enjoy a tax-free cash entitlement, which you might be able to use to meet some of your needs. For DC this will usually be 25% of the fund value when you ‘crystallise’ it. This just means choosing a retirement income option such as drawdown or buying an annuity.
DB pensions also come with a 25% tax-free cash entitlement, although this will be calculated by an actuary based on the value of your pension and available when your retirement income is paid from the scheme.
This is one of the most important financial decisions you will make, so consider taking regulated financial advice. If your DB pension is valued at £30,000 or more you will need to take advice before going ahead with a transfer anyway. This advice should account for all your personal circumstances, including whether you have a spouse or not.