Whether you’re planning ahead for retirement or already drawing an income from your pension pot, the rising cost of living may be cause for concern.
Keeping up with inflation is challenging, and over the decades its impact on your retirement savings and spending power can be dramatic. Meanwhile, stock market volatility is reducing investment returns, and it may feel harder than ever to ensure your pot will last for the rest of your life.
Below, we look at several ways to potentially maximise your retirement income, and some important factors to consider when you’re taking an income from your pension.
Top up your state pension
For many people, the state pension forms the bedrock of retirement income. The full new state pension stands at £185.15 for the 2022/23 tax year, but the exact amount you receive is based on your National Insurance (NI) record. You need 35 ‘qualifying NI years’ to receive a full state pension, and at least 10 years’ worth to receive any state pension at all.
If you’re missing just one year of NI contributions, this costs you around £275 a year in state pension. You can check your record at gov.uk, and if you discover there are gaps, you can top up your record by paying ‘voluntary class 3 NI contributions’ which cost £824.20 for a full year, or £15.85 for a week.
Becky O’Connor, head of pensions and savings at interactive investor, says it can be money well spent: “For an initial outlay on a year’s worth of voluntary contributions, you may be able to make the money back within three years of drawing your pension. After that, you’d be profiting from your decision to buy an additional year.”
However, she adds that it’s not a straightforward option and won’t be right for everyone. If you’re considering this, you really need to contact the Future Pension Centre to find out if it’s worthwhile given your personal situation. You can also use the online tool from pension consultancy Lane Clark & Peacock to help you to decide whether it’s worth paying voluntary NI contributions.
Bear in mind that you have until the end of the 2022/23 tax year to make up for gaps in your record back to 2006 if you’re a man born after 5 April 1951 or a woman born after 5 April 1953. After April 2023, you can only buy missing years from the last six years.
Delay your retirement
Delaying your retirement may give your pension time to recover from stock market falls, and potentially keep up with future rises in living costs. For every nine weeks you defer taking your state pension, your payments increase by 1 per cent. If you delay it for a year, you get an uplift of about 5.8 per cent, which amounts to an extra £10.42 per week for the rest of your life.
Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, says: “Timing is very important – you may have reached an age where you can access your state and workplace pensions, but if you don’t need the money then you can delay until you do. This means you can benefit from an increased level of state pension and your workplace pension has longer to grow.”
Besides, you may, for example, be prepared to carry on working part-time, or have other income from a buy-to-let income or money in individual savings accounts (Isas) that can top up your income.
By delaying accessing your pensions, you avoid liquidating pension assets during a market slump – although there are no guarantees that your pension will recover in value over time. But the longer your pension remains invested, the greater the chance of recovery and a higher pension income when you eventually retire. Also, by delaying retirement, your pension won’t have to last as long as if you’d taken it, say, six years earlier.
In addition, you may be able to continue to build up your pension. You can continue to receive tax relief on your pension contributions up until the age of 75, and if you receive employer contributions, you’ll benefit from these too if you continue working.
Move to a cheaper provider and consolidate pensions
When it comes to maximising your pension and its income, low platform charges are particularly important, as these fees eat away at your returns over the years. “Depending on your pot size, a low, flat fee could be a lot cheaper for you than a percentage fee,” says O’Connor.
Interactive investor, for example, offers a ‘Pension Builder’ for pension-only customers for a flat fee of £12.99 per month. Some examples of other low-cost providers include Bestinvest, which has a starting platform fee of 0.2 per cent, with a dealing fee of £4.95 per trade for listed securities. However, remember that the more you have saved in your pot, the greater the amount you’ll pay with a percentage-based fee. You can use the calculator at Comparetheplatform.com to help you find the most suitable and cheapest provider for you.
Consider moving any old pension pots you may have to a low-cost provider, but read the terms to make sure you’re not losing valuable benefits in the process. “Be careful with older style pensions, as they may have enhanced tax-free cash, or in-built bonuses that you’d lose in a transfer,” warns Amanda Redman of Amanda Redman Financial Planning.
Review your investment portfolio
You may want to focus on income or dividend-producing investments in retirement, but beating inflation seems impossible at present as it’s predicted to hit 11 per cent this year. Ideally, you want to retain a mixture of investments, including income and growth-focused shares.
O’Connor says: “It's worth looking at whether your portfolio is diversified enough to weather turbulent economic conditions as you approach and enter retirement, with a good range of assets, geographies and risk profiles.”
Redman recommends adding commercial property funds and alternatives such as commodity exchange traded funds to an investment portfolio. She says: “Commercial property funds investing in industrial and warehouse space have been performing well, driven by the trends we’ve seen emerging since the Covid pandemic started.
“Absolute return funds can also be useful within a portfolio, as they seek to derive returns in a very different way from traditional bonds and equities. However, if you are making investment decisions yourself rather than working with an adviser, it’s important to research these funds carefully to fully understand their investment strategy.”
Minimise your pension tax bill
You can withdraw up to 25 per cent tax free from a defined contribution pension when you reach the age of 55, but the rest will be taxed as income at your highest rate. Additionally, you have a personal allowance that enables you to earn up to £12,570 in the 2022/23 tax year, and the less taxable income you take beyond this, the lower your tax bill will be.
As a general rule, and particularly during volatile stock market periods, only take what you need from your pension each year. If you have an Isa, you could take tax-free cash from it to top up those withdrawals.
If you take cash directly from your pension rather than moving your money into a flexi-access drawdown account, this is known as an uncrystallised funds pension lump sum (UFPLS). Each UFPLS withdrawal from your pension includes a 25 per cent tax-free element, and you pay income tax on the balance. Redman says: “If you’re living off cash savings in this way, and not receiving other taxable income, you can withdraw £16,760 a year tax free from your pension, using the 25 per cent rule and your personal allowance.”
Make careful use of pension drawdown
Pension drawdown is a flexible tool for maximising your income in retirement, as you choose how and when you draw an income from your pot. The risk is, though, that you take too much too soon, and the current environment of rising prices and falling global markets makes managing drawdown difficult.
Tom Selby, head of retirement policy at AJ Bell, says: “This is not a reason to panic. The most important thing is to review your strategy regularly, and be prepared to tighten your belt if your pension value takes a short-term hit.”
It’s important to avoid drawing too much from your pot as this could put too big a dent in your capital, leaving you without any choice but to cut spending in later life. Morrissey says: “Adopting a natural yield strategy where you take only the income produced from your investments is one way to manage this. It’s also important to remember that you don’t need to adopt an all-annuity or all-income drawdown approach to retirement.”
Don’t forget annuities
Since the introduction of pension freedoms in April 2015, you can do as you wish with your pension, and you can choose the timing, too. For example, you could buy an annuity for some guaranteed income, while leaving the rest invested where it can benefit from investment growth. Annuities become more attractive as investors get older, partly because rates improve as life expectancy declines and may be further enhanced by declining health, but also in some cases because people don’t want the burden and uncertainty of pension investment as they get older.
There is plenty of choice and flexibility in the pension system, but it can be a complex business to manage the various options as you approach retirement. This is one time when independent financial advice may be money well spent.