As you enter your sixth decade you will be getting closer to the time at which you begin to wind down your career and start thinking seriously about retirement.

In the third part of this series, AJ Bell senior analyst Tom Selby looks at some of the key things pension savers in their 50s should be thinking about – including when and how to take a retirement income.

Accessing your pension

If you’re aged 55 or over then you have the option to access your defined contribution pension pot, with 25% available tax-free and the rest taxed in the same way as income. The point at which you can ‘flexibly access’ your pension is due to rise to 57 by 2028.

However, just because you can access your hard-earned retirement fund doesn’t necessarily mean you should.

The earlier you access your pension, the longer it will potentially have to last for in retirement – and if you draw too much, too soon you will risk running out of money early.

To give you a rough idea of how far your pension pot might stretch, let’s assume a saver with a £100,000 fund needs £5,000 a year from their fund to support their lifestyle, with the income going up each year in line with 2% expected inflation.

If they achieve investment returns of 4% after charges, their fund could be expected to last around 25 years. For someone taking an income from age 55, that implies they risk running out of money by age 80.

Given average life expectancy at age 55 is 84 for men and 87 for women, if they are in good health there is a fair chance they will spend their remaining years relying solely on the state pension. The flat-rate state pension is currently worth £175.20 a week or just over £9,000 a year.

Assuming life expectancy in the UK continues to rise there is a decent chance someone in their 50s will live well into their 90s.

Tax consequences

You should also consider the impact accessing your pension will have on the tax you pay. If you opt for big withdrawals – or indeed plan to take your entire fund out in one go – you risk pushing yourself into a higher income tax bracket. By drip feeding withdrawals slowly, you can not only prolong the life of your pension but reduce the amount of tax you pay into the bargain.

Anyone accessing taxable income from their defined contribution pension needs to be aware of the impact of the money purchase annual allowance (MPAA). If you access even £1 of taxable income flexibly from your fund, your annual allowance will be lowered from £40,000 to just £4,000.

Furthermore, you will lose the ability to ‘carry forward’ unused allowances from the three previous tax years. At worst, the MPAA will reduce your total available allowance in the current tax year, inclusive of carry forward, from £160,000 to £4,000.

Note that you won’t trigger the MPAA if you buy an annuity, just take your 25% tax-free cash or take a ‘small pots’ withdrawal. A small pots withdrawal is where you fully extinguish a pension worth £10,000 or less, with 25% of the withdrawal tax-free and the rest taxed as income. You can make unlimited small pots withdrawals for occupational schemes and up to three withdrawals for non-occupational schemes (such as SIPPs).

Consider consolidating your pensions in one place

As your chosen retirement date edges closer, you might want to consider tracking down any old pensions you have and consolidating them with a single provider. The Government’s pension tracing service is a good place to start, while plans are also afoot to build pensions dashboards which in the future could allow you to see all your retirement pots in one place online.

There are many good reasons to do this. Firstly, it is an opportunity to lower your charges, something which can have a profoundly positive impact on your retirement, particularly over the longer term.

Secondly, it is a lot easier to manage a single pension versus lot of different pots with different providers. You may also be able to access greater choice and flexibility by transferring, both in terms of the investments available and the withdrawal options open to you.

However, there are also reasons to be careful before transferring your pensions. In particular, some older-style pensions have valuable guarantees attached which will be lost if you switch to a different provider, so make sure you check your documentation and speak to your existing provider before making a transfer.

In addition, some older policies also have exit fees which can make it expensive to move your money.

High earners and those with big pensions may face retirement complexity

A few of us may become exposed to the more complex parts of the pensions universe as we reach our 50s. These include the lifetime allowance and tapered annual allowance.

The lifetime allowance is a cap on the amount you can save in a pension over the course of your life and is currently set at £1,073,100. If you go over the lifetime allowance when accessing your pension you will pay a tax charge designed to return the tax relief you have received.

While most people enjoy a £40,000 pensions annual allowance, those with ‘threshold’ income above £200,000 and ‘adjusted’ income above £240,000 have their annual allowance reduced by £1 for every £2 of adjusted income earned above £240,000, to a minimum of £4,000 for those with adjusted income of £312,000 or more.

Note that both income measures include not just salary but other taxable income too. Threshold income also deducts any personal pension contributions, while adjusted income adds employer contributions.

Those with generous defined benefit entitlements, such as senior doctors, have been among those caught by the complexity of the taper. Again, if you breach your allowance the taxman will come for any tax relief you have received over and above your annual allowance.

Given how difficult this is to navigate, I would strongly recommend speaking to a regulated financial adviser if you think you are caught by either of these parts of the system.

Get your investments in order

If you’re planning to access your pension in the next 5 or 10 years, you should start thinking about how you want to generate an income from your fund. Depending on the option you choose, this may have a big impact on how you invest your money.

A 55-year-old planning to stop working at 60 and use their entire fund to buy an annuity, for example, will likely want to reduce the amount of investment risk they are taking as they approach their chosen retirement date. The same could be said for those who plan to take their entire fund as cash.

Failing to do this would leave you a hostage to fortune because stock markets can be volatile, particularly over the short-term. The double-digit falls in fund values we saw as a result Covid-19 in March and April are a perfect example of this.

If you’re planning to stay invested in retirement and take an income via drawdown, it is worth reviewing your investments as you approach your retirement date. However, this may not necessitate a big change as your investment time horizon will be longer than someone planning to buy an annuity or take their fund as cash in one go.

If you have children and grandchildren consider building a nest egg for them too.

For lots of savers in their 50s the focus isn’t just on their own savings but building a pot of money tax efficiently for their children and grandchildren as well.

If this is a priority there are two ‘junior’ versions of traditional savings products you could consider.

Saving for the kids and grandkids

You can save up to £2,880 on your child’s behalf in a Junior SIPP and it will be topped up automatically via pension tax relief to £3,600. The mechanics of tax relief are exactly the same as for an adult saver, just with a lower annual contribution limit.

In all other ways a Junior SIPP works in exactly the same way as a regular SIPP, with 25% of the pot available tax-free from age 55 (due to rise to age 57 in 2028) and the rest taxed in the same way as income.

The other main option is a Junior ISA. Junior ISAs received a significant boost at the latest Budget, with the annual allowance more than doubling from £4,368 to £9,000. Once your child reaches age 18 their Junior ISA will convert into an adult ISA and they will be able to access the money-tax-free.

The increase in the Junior ISA allowance means a parent who started saving in one for a newborn child could build a tax-free pot of more than £240,000 by the time their child reaches 18, assuming they put the maximum in each year and it grows by 4% every year after charges.

If you have children or grandchildren aged 18-39 who want to get on the housing ladder, you could also consider funding a Lifetime ISA in their name.

All contributions up to £4,000 would benefit from an upfront bonus of 25% (up to a maximum of £1,000 per year), and your child or grandchild could withdraw the money tax-free to put towards a deposit on their first home.

Withdrawals are also tax-free when you reach age 60 or if you become terminally ill, but in other circumstances a 25% early withdrawal charge will be applied by the Government (note this has recently been reduced to 20% for the 2020/21 tax year, although the Government plans to increase it back to 25% for 2021/22 onwards).

COMING SOON

Don’t miss next week’s article, covering how people in their 60s and beyond should go about managing their pension.

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