Harvest the most from your pension pot

There are many important choices you make in life, but few are as important as the decision you make about how you tap into your pension when you retire. This will influence the level of income you receive for the rest of your life – and making the right choice can potentially increase your annual income by 30% or more.

When it comes to turning your pension fund into income, doing your homework is therefore essential. "One of the biggest problems at retirement is apathy," says Tim Whiting, proposition director at Alexander Forbes Annuity Bureau.

"People get a letter from their pension provider telling them they'll give them an annuity of so much a year and they just accept this. It's essential to shop around; on average we obtain around 20% more income for our clients, just on ordinary rates. If you have any health or lifestyle issues then this uplift can be even higher."

As well as being prepared to shop around, Tom McPhail, head of pensions research at Hargreaves Lansdown, says it's essential to make the right choice about how you take your pension income. "People get hung up on the rate but the type of retirement income is also important.

What you take and when affects death benefits, tax planning and how you manage other assets, so it's important to get that right too," he explains, adding that he often recommends a combination of different options.


The most common way to take an income from your pension is with an annuity, which provides a regular income for life in exchange for a lump sum. Whiting says: "They're still the correct answer for the vast majority of people." In most cases, you have to take an annuity by the age of 75.

The amount you receive is dependent on your life expectancy, so the older you are the more you will receive. Likewise, because women live longer than men on average, they receive a lower amount.

For example, according to figures from Alexander Forbes Annuity Bureau, a 60-year-old man with a £100,000 pension would receive an annuity of £6,450 a year with a five-year guarantee. If he waited until 65 this would increase to £7,180. A woman aged 60 would get £6,120 a year.

Other options can be built into your annuity which will affect the amount you receive. You can inflation-proof your annuity. This ensures it rises either in line with the retail prices index (RPI) or by 3% each year, but to do this you will have to take a lower annuity initially.

You can also add a guarantee to your annuity, usually for five or 10 years. This gives you the security that if you die prematurely the income you would have received up to the end of the guarantee will be paid to your dependants. Again, you'll see your income level drop if you add a guarantee, although this is only marginal, especially for younger lives.

Another common option on annuities is a spouse's pension. This ensures that if you die first, your partner will receive an income for life. It does mean a significant drop in your starting income though. For example a 60-year-old man adding a spouse's pension to his pension for his 57-year-old wife would receive a level annuity of £5,930, compared with £6,450 if he'd taken a single annuity.
As well as standard annuities, it's also possible to take out an enhanced or impaired annuity if you have any health or lifestyle condition that might affect your life expectancy. This will give you an increased income.

Guaranteed income for life
No investment risk


You can't change your annuity once you've taken it out
If you die prematurely, your pension fund is lost
(apart from any covered by a guarantee)

Variable and third way annuities

Variable and third way annuities take the standard annuity a step further, allowing more flexibility and the option for investment growth, while retaining an element of guarantee.
"Variable annuities offer some investment growth potential," says Whiting. These include with-profits and unit-linked annuities where the pot is invested so income can rise and fall dependent on market conditions.
"They're not common because people tend to be more cautious at retirement but they can work if you have a large fund and you're prepared to take some risk with your pension pot," he adds.
Unlike annuities, they're not a permanent solution, so if your situation changes or you want a different type of retirement income, you can shift to another product.

Greater flexibility around income streams
Opportunity for investment growth
Guarantees on the level of income and the size of your pension fund
Annuity rates could increase or your health could worsen to enable you to obtain a better rate
Investments could perform badly
Annuity rates could drop and reduce your future income
More expensive than traditional annuities

Unsecured pension

If the concept of fixing your income for life with an annuity leaves you cold, you might want to consider an unsecured pension (USP), also known as income drawdown. As with any other pension, you can draw 25% tax-free cash at the outset, but then you can leave the rest of your pension pot invested.

Income drawdown is very flexible: you can draw down anything from 0% to 120% of the annual income that could be paid if your fund was used to buy a single-life annuity. This amount is reviewed every five years.
The other key advantage is, because you haven't exchanged your pension fund for an annuity, death benefits can go to your dependants. If you die, they can either continue to draw money from the fund, convert it into an annuity or take the money, after paying 35% tax on it.

Although it can be tempting to take as much income as you're allowed, there is a real risk that you'll reduce your future income levels. "Research by Fidelity found that you need to restrict the amount of income you take to less than 4% to ensure your income keeps pace with inflation," explains Nigel Barlow, head of research at Just Retirement.

"And if there's a stockmarket crash you could find it very hard to recover without forfeiting income."

Because of this risk, and the charges and advice required with USP, Barlow says you should only consider it if you have a large fund.

Allows you to control your retirement income
Can remain invested to benefit from potential growth
No tie-ins – can take an annuity at any point
Investment returns might be poor, reducing your pension pot
Annuity rates could worsen

Scheme pension

A scheme pension takes advantage of the rules surrounding occupational schemes where the trustees pay an income from the pension fund rather than forcing you to take out an annuity. "An actuary assesses your life expectancy and sets an income, which will be broadly in line with what you would have got from an annuity," says McPhail.

"But, because the pension pot is still invested, this is more akin to income drawdown than to an annuity."

The level of income you receive can be reviewed and adjusted and it's also possible to put a guarantee in place for up to 10 years, to ensure that if you die during that term, payments continue.

You can also combine your pension with those of other family members or directors of your firm, with the option to allow any remaining funds to pass to other members when you die. 

A scheme pension can prove particularly attractive to people with shortened life expectancy as their income can be enhanced, and to those with an alternative secured pension (ASP) who find their income slipping due to the age 75 annuity reference point.

But this approach isn't for everyone as Barlow explains: "Because of the costs and the nature of the scheme, this really appeals to the wealthy or to a family business."

Income levels can be regularly reviewed, which might result in a higher income if your health deteriorates

Allows you to take a higher level of income than with ASP
Can benefit from future fund growth
Can pass funds to other scheme members

Income could be reduced if investment performance is poor
Charges can be high


Alternatively Secured Pension (ASP)

The ASP was regarded as the solution to having to take an annuity at age 75 when it was first introduced in 2006. But, with hefty taxes on death benefits as well as restrictions on what you can take, it's now seen very much as a minority product.

An ASP is very similar to an USP. However, you can only draw down between 55% and 90% of the single life annuity for a 75-year-old. This is reviewed every year although your income levels will always be assessed against an annuity for a 75-year-old.

Michael Owen, financial planning director at Brooks MacDonald Financial Consulting, warns that these rules could mean your income reduces during retirement. "If you take too much or your investments don't perform you will see a reduction in your income or face having to increase the investment risk in your fund," he explains.

The death benefits are the other major turn-off with ASPs. "A spouse could take a pension from the fund but if this isn't an option then any money left could potentially be taxed at 82% unless it is left to charity," says Owen.


Alternative to taking an annuity at age 75
Some flexibility over the income level you take
Can remain invested to benefit from potential growth
The amount you can take could reduce if your pension pot doesn't grow sufficiently
Drawdown limits are lower than for USP and based on an annuity for a 75-year-old
Death benefits are restrictive and your fund could be subject to hefty taxation

Frequently Asked Questions...

Q: Do I need professional advice?

A: Because of the significance of the steps you take at retirement, advice is definitely worth taking. Some advisers will charge a fee for advice, especially if you only have a small fund, but many will take commission from the provider.

But, even if it costs you £500 to get advice, this could soon pay for itself if you secure a higher income in retirement.

Find an IFA in your local area for free

Q: What is an enhanced annuity?

A: Whether you smoke or are a little on the heavy side, have a relatively minor condition such as high blood pressure or diabetes, or a serious life-threatening medical condition such as cancer or heart disease, you may be able to qualify for an enhanced annuity rate.

Aston Goodey, director of sales and marketing at MGM Advantage, says: "A smoker would get an uplift of around 10% on a standard rate while more serious conditions could see the rate double or more."

If you have minor health issues you should only need to complete a questionnaire to obtain an enhanced rate although some companies will ask for a GP report with less straightforward cases.
"We're encouraged through life to hide medical conditions but it's important you tell us everything at this stage as it could increase your annuity rate," says Goodey. Even if you think you're perfectly healthy it's worth checking whether you qualify.

Estimates vary on the number of people who could get higher rates, with numbers ranging from 30% to more than 60% of the population. Some providers also offer enhanced rates to people living in certain postcodes or according to occupation.

Q: What other ways can I secure an income in retirement?

A: Your pension doesn't have to be the only source of income in retirement and many people rely on a variety of sources to support their lifestyle.

Savings and investments are common, with high interest accounts and income generating assets such as corporate bonds and equity income funds popular choices.
Your property can also serve as a source of income. If it's palatable, taking in a lodger can provide regular income, with the first £4,250 a year tax-free under the government's Rent a Room scheme.

Alternatively, releasing money from your home, either by downsizing or by taking out an equity release scheme, will provide capital to generate an income.

Returning to work is another option. There are no restrictions on when you have to stop working and some firms encourage older people to work for them.

Benefits can also form an important part of your income in retirement. "A large proportion of people don't bother to claim the benefits they're entitled to," says Nigel Barlow, head of research at Just Retirement. "It's not charity; you've paid for them through your working life."
Among the benefits you might be able to claim are pension credit and council tax benefit. Website entitledto.co.uk can help identify any benefits you should be claiming.