How To Access Your Pension Funds (without the complexity and jargon!)
If you’re in or around your 50s, you might well be thinking a lot about life after work.
Specifically, you might be thinking about accessing your pensions and asking yourself a bunch of questions like:
“How much money will I have when I retire?”
“I’ve got several different pension pots… what do they all mean? Would it be better to put them together?”
Do I have ‘enough in the tank’? “Am I going to have enough without worrying about money?”
“When I do finally retire, how do I access the money?”
And maybe an additional question:
“How much will it cost me to get all these answers?”
Pensions can be confusing, especially since a lot of the language and jargon is alien to us.
So, in this guide I’ll walk you through how they work. By the end of it, you’ll know:
- What the different types of pensions are
- What happens when you start taking them
- The main ways of receiving your pension
- Some advantages and disadvantages
- Where to go for more information?
What are the different types of pension pot?
Broadly speaking, there’s two types of pensions:
1) Ones your employer pays into
2) Ones you pay into yourself (e.g. as a self-employed person)
Plus there’s another thing to think about:
3) State pension: the minimum pension (almost) everyone gets when they reach retirement
I’ll walk through each one in turn.
Employer-based pensions
There are generally two types.
The first type depends on your ‘salary’ – i.e., your salary at the point you retire or your average salary over a certain number of working years. They’re normally called ’final salary’ or ‘defined benefit’ pensions. So far, so simple.
The second type depends on what contributions you and your employer have paid in. They’re often called ‘defined contribution’ or ‘money purchase’ pensions. (I know - more catchy titles!)
Does it matter which one you have? Perhaps. Final salary pensions are more secure because you know what you’re going to get as a pension for the rest of your life, but defined contribution pensions can also be great. They’re different ways of paying you an income when you retire.
The main thing to understand is that, over the years you work for your employer, you’ve been saving up a pension pot (or pots) or a defined benefit entitlement in the background.
Self-employed pensions / savings
If you’re self-employed (or have been self-employed at any point in your career), you might have paid some money into a pension pot.
Even if you weren’t self-employed, you might have put some money aside anyway, whether in a specific pension pot or just into savings or investments accounts.
The key here is that this is money you yourself have set aside, designed to give you an income in retirement.
You might have lots of different bits – some money from an employee’s pension, some money in your savings, some money paid directly into a pension scheme, etc.
Again, the details don’t matter too much here – as long as there’s enough money waiting for you when you get to retirement!
(Not to be confused with) State Pension
A State Pension is not like the other pensions, because it’s not linked to how much you’ve saved or how much you’ve earned through your years of employment.
It’s more a basic allowance that everyone gets when they reach retirement age.
There’s a maximum amount you’re entitled to – but to claim it you also need to have paid National Insurance contributions.
And the amount you get is based on how much National Insurance you’ve paid over the course of your lifetime.
(We’ll put State Pension to one side for now – I just wanted you to be aware of it!)
From what age can I access my pension?
So, we’ve established that you may have one or more pots of money saved up somewhere, growing through investment, ready for the moment you retire and want to start accessing them.
But when can you access your pension?
Generally, the short answer is that you generally can’t access them until you’re aged 55, at the earliest. It’s usually later for final salary pensions.
This number keeps going up, and is likely to go up again soon (to 57 or 58; the Government confirmed this will happen from 2028).
BUT, there might be exceptions: if you’re in poor health, or work in a profession where people normally retire earlier, for example if you’re an athlete.
[Side note: if you happen to be an athlete reading this, try to grab us some more medals at the next Olympics, would you?]
How do I access my pension? 2 broad routes
(It’s worth emphasising here: none of this is meant to be specific financial advice – I’m just helping you understand what your options are!)
I’m focusing here on your money purchase pensions. If you’re lucky enough to have a final salary pension, that will, generally, take care of itself.
Wherever your pension is now, at some point you’ll need to decide HOW you want to claim it.
There are two broad ways you can do this: an Annuity or a Drawdown.
This section is really important: I want you to know and understand what your options are here because the more you understand, the more you can trust the financial advice you’re getting!)
This is also where it gets a bit more fiddly… so bear with me.
Route 1 – Annuity
The first route is something called an ‘Annuity’.
‘Hang on, Marco!’ I can hear you saying, ‘I thought you hated jargon – but you’re using it on me now!’
Ok, ok, I know – I’ll explain in simple terms what an annuity is.
An annuity is where you give your pension to an ‘annuity company’ (perhaps a company like Aviva, Legal & General, Scottish Widows – but there are loads of others) and in return they pay you an income for the rest of your life.
‘But what’s the point,’ I hear you ask, ‘of paying a company my money just so they can pay it back again?’
Well, this is the clever bit. The annuity company will find out lots of things about you (your age, whether you smoke, where you live, any pre-existing health conditions, etc) and then offer to pay you a fixed amount on a regular basis (normally each month).
Basically, they’re trying to work out how long you’re going to live for, and hope they end up paying you LESS than you’ve paid them in the first place. It’s a sort of game:
- You want to live as long as possible, and keep getting paid however long that is
- They want you to die as soon as possible so they can stop paying you
(When I put it like that, I make them sound a little evil, but that’s at least how the maths of it works. You could say it’s a taking a bit of a punt! )
To use a quick example with numbers:
Let’s say your pension pot is worth £120,000 when you retire.
You go to an annuity provider called Evil Money Grabbers Ltd and they offer you an annuity of £6,000 a year.
Not put off by their name, you accept the offer and start receiving your £500 a month. If you live another thirty years, that’s their problem – they still have to keep paying you… but they are hoping you live less than 20 years, because then they’ll have received more than they’ve paid you back.
There’s quite a lot of options open to you if you choose an annuity. For example, you could have a level income or one that goes up with inflation. Or, you could have one that pays an income to your spouse if you die before them. All the options will impact on the level of income you get.
So hopefully that’s one more piece of jargon that’s been busted!
Let’s move onto the pros and cons of an annuity
The pros and cons of an Annuity
The biggest disadvantage is that when you die, your annuity money could go with you (depending on whether or not you’ve set it up so your spouse continues to receive an income).
You might have left a LOT of money on the table, and it could be that none of it will pass onto your family or loved ones.
On the plus side though, an annuity is clear and predictable. You agree the deal and then sit back and get your monthly cheque. For lots of people this is good. They don’t have to think about it.
Another advantage is that you don’t need ongoing financial advice – which means less money spent on financial advisers (like me!)
So, if you’re the sort of person who prefers clarity, simplicity and predictability over flexibility, an annuity might be for you.
But a lot of people prefer that flexibility, which brings us onto our second route – something that is becoming a far more popular option for people nowadays…
Route 2 – Drawdown
Ready to bust some more jargon?
A Drawdown is far more flexible. You can set it up at the start, any way you like, but it can be changed as you go – there are no permanent, set-in-stone decisions… nothing you have to live with for the rest of your retired life.
How do they work?
Normally, you put all your pension money into one ‘drawdown’ pot, a big (hopefully!) pot of money you can do what you want with. This pot stays invested in the markets in the same way your pension pots did.
The idea is that you can pay yourself, say, a monthly allowance from the pot. You can stop or increase or decrease these monthly payments, it’s all very flexible.
You can also take out lump sums whenever you want.
Planning to pay for your grandchild’s wedding? No problem, you can take some money from your Drawdown pot!
Want to pay your other grandchild’s university tuition fees? (Who cares that they didn’t do the degree you wanted them to!) The Drawdown pot is there for you.
And whatever’s left in the pot will be invested and continue to grow.
Just bear in mind that, the smaller your Drawdown pot, the less money you have to play with … so if you take out any lump sums, or take too much income this will affect your Drawdown in the background.
In fact, that brings us onto the pros and cons of a Drawdown.
The pros and cons of a Drawdown
As we know, investing can be risky and any growth is unpredictable. Knowing when the best time is to withdraw big lump sums, what monthly income you should pay yourself, what investments to set up within it can be complicated and all of this probably needs financial advice and that means cost!
BUT, a huge benefit of a Drawdown is that it normally comes with what’s called ‘Death Benefits’. No, this isn’t a heavy metal band from the 1970s. What this means is that when you die, whatever’s left in your Drawdown pot would pass onto your loved ones.
In that sense, there’s no risk of you dying much earlier than you expect (like with an annuity) and all the money just vanishing…
So, the pros and cons of a Drawdown are really the flipsides of those for an Annuity. They’re two sides of the same coin.
(Just to remind you again – none of this is specific financial advice, just some guidance on how it all works!)
Extra bonus point: 25% tax-free allowance
A final important thing to understand about accessing your pension, whichever route you take, is that you’re generally entitled to a tax-free chunk of 25% of it, if you want it.
(Some older or ‘special’ types of pensions give you more than 25% but they’re very much the exception to the norm.)
With an Annuity, normally this has to be removed at the start, but with a Drawdown it can be taken out whenever you want… and you don’t need to take out all of it at once, etc.
What to do with that 25% chunk? That depends on your needs and the advice you get from your financial adviser!
The End! (And where to go next…?)
Everyone’s circumstances will be different. Not just your dreams for your retirement, but your health, family circumstances, the economy, when you retire, the pension providers available, etc… there are so many factors.
A good adviser doesn’t just know how to organise your money now – say, by switching your pension provider – but can help you make good decisions about your future.
That’s why it’s so important to find a financial adviser who cares about YOU and takes the time to understand YOUR needs.
I’ve written a whole other guide about how to find a great financial adviser – you can read it here – and all the same advice applies in thinking about your pensions.
But you should now have a clearer idea of how accessing your pension works along with the broad options (and their pros and cons).
And I’m always here for a free, no obligation chat if you want to find out more!
Thanks for reading!