Hello and thanks for your interest!
This mega-blog should be helpful to people who are 55 or older and have money “stuck” in pensions which they could do with to replace income from work.
“Stuck” is the right word, most of us would like our money back to spend at some point but don’t know the rules for getting at it and fear we’d make a hash of things if we did it ourselves. This blog is a self-help manual for us lot – and I hope it will be a fun read.
It may also be helpful if you are planning for the future or if you are trying to help others.
Preparation Step one – do your background reading
My first piece of advice is that when you’ve finished reading this article, you press on this link and read Factsheet 91 from Age UK.
This goes into much more detail than I can here and deals with subjects like the integration of pensions and the benefits you can receive at working age and as pension credits
It also contains valuable advice on avoiding scams, avoiding falling foul of the Inland Revenue and the DWP’s support for those needing (long-term) social care.
Preparation Step two – Think about your need for cash in the bank
Having a rainy day fund for unexpected costs is a good thing. It’s money that can earn interest (as in the Santander 123 account) , it might be money you have in cash ISAs, the important thing is that it’s money that you can get at within a few days without having to worry about stock-markets and withdrawal penalties.
This is your “contingency” fund. You only need it to have enough in it to make you feel secure, it should not have all your savings in it. It’s a common mistake to have all your money in low or no interest accounts rather than working as hard as you do – or did!
You may have enough money in accounts or even too much. If you think you have too much in the bank, then you can start thinking of investing some of that money for the future. If you don’t have enough money in your rainy day fund, your pension may be able to help.
Preparation Step two – think about your debts.
If you have paid off your mortgage and have no debts, skip this bit. If you still have debt then the key questions are when that debt comes due and have you got the ability to meet the repayments. If you are comfortable that you can repay your debts from your income then pensions don’t come into it, but you should know that if worse comes to worse, you can take 25% of your pension pot, without having to pay any tax on it. That money can be used to clear debt.
Preparation Step three – think about your future
You are heading into holiday-time. As you get into your sixties and seventies , you are likely to work less hard and for shorter, that’s why we have pensions, to take up the slack in income and make sure we can do the things we promised ourselves we could do , later on.
You should find out what is due to you as a State Pension and you can do so by pressing this link. You can get a state pension forecast – unique to you – quickly and in a user-friendly statement. Hopefully it will be good news. The State Pension has got better for most people and is much simpler than it used to be. Plan on having a pension in today’s money of around £8000 from 66, 67 or 68 – depending on how old you are – the younger you are the longer you’ll have to wait!
You may have some DB pension owed to you by the trustees of employers you’ve worked for, if you do have , make sure you have an estimate of what is coming to you and when
When you have your state pension, you can start thinking about how you’d like to dovetail work and pensions. What you take out of your pot as a pension should be to fill in the gaps.
For heaven sake – don’t get too strung on getting a financial plan in place where every eventuality is covered. Life isn’t like that, there are bound to be surprises (good and bad). But remember you have your rainy day fund and make sure you think about the other things you own which you could sell – like shares, ISAs and even investment property.
Finally – think about your house and ask yourself if you really could realise any of the equity in it. It’s not as easy to downsize as you think, especially if you have kids and grandkids. A lot of people think their house is their pension and you can turn bricks into sausages if you qualify for an equity release plan – you can find out about equity release by reading the Equity Release Council’s frequently asked questions.
You could also have a look at Legal and General’s LifeTime mortgage options, which show how equity release works in practice
How to turn your pot into a pension
One pot policy.
You’ll notice that the headline implies one pot. I strongly suggest that you try to bring all your pensions together into one pot and that pot is with a pension provider that you feel comfortable can help you as an individual – do what you want to do.
Don’t think this will be easy or quick, your portfolio of pension pots could run to 10 or more and many of them will have quirks in them that you need to research. Be particularly careful about guarantees, early exit penalties and loyalty bonuses. Transferring pots can be a tricky business. I will be writing more on this in weeks to come.
Do I need guarantees?
Once you’ve got your pot portfolio into one place, the first question you need to ask of yourself is how important guarantees are. If you want a guaranteed income you have to buy an annuity. George Osborne said that nobody would have to buy an annuity again but nobody’s found a way of turning a pot into a guaranteed pension that lasts as long as you do, that isn’t called “annuity”.
There are a lot of different types of annuity and the key – if this is where your search for a pension ends up is to shop around. My advice is to go and read the stuff on this page from the Money Advice Service .
It may be that you already got guaranteed DB pensions or even guaranteed annuity rates in your DC pots, they are good news and form the platform for your pension , only ditch guarantees you already have after a lot of thought (and take advice).
Would I prefer guarantees – yes – but can I afford them!
What you’ll find when you are working your way through your options is that you are always having to make trade- offs like the one in the title of this bit.
Planning for the future is about guesses – they include guesses which are hugely important like how long you’re going to live, will you need social care as you get weaker and whether you’ll need more or less income the older you get. There are no certain answers to these questions so if you can’t afford to guarantee you have an income to meet all eventualities – at least you’ve got a lot of freedom over how you spend your pension pot.
The pension you,ll be offered from a guaranteed annuity is likely to be a lot less than you thought you’d get for your savings. That’s why most people move on to other ways of providing a pension.
Would I like money now – or money later?
This trade off is not as simple as it seems. Of course we’d like money now but most people are cautious and save rather than spend. You can save too much and become a hoarder, not spending your money now may be something you regret in later life, when you can’t do the things you’d wished you’d done when you were younger.
But if you blow all your money in your fifties, not only will you be skint in later life , but you may well have given much of your savings to the tax-man. Getting the balance right on the shape of your pension is important. Ideally you’d have a financial advisor helping you here to do your cashflow planning (though every plan comes unstuck somewhere).
If you’d like to do some cashflow planning for your retirement, I’m afraid there is precious little software in the public domain to do so. I am looking into creating a utility for AgeWage in conjunction with some altruistic actuaries. For now we will have to make do with simple rules of thumb, which help us to set our pension from our savings,
Getting the pension rate right
Ok – so we’ve looked at the future and decided we don’t know, we’ve decided that annuities may be too expensive and we’ve decided to look at alternatives.
There is currently only one alternative to an annuity (for your savings) and that is something called drawdown. Drawdown is a pension you pay yourself from your pension pot and you have the freedom to have it paid any way you want. Sounds good eh!
Well not so fast…
- If you screw this up you will run out of money later in life
- If you screw this up you could end up giving a good part of your pension (unnecessarily) to the taxman
- If you screw this up you could unwittingly deny yourself the chance of the state paying for later life social care
Which is why paying attention to your pension is very important when you are making decisions in your fifties and sixties
The 4% rule of thumb
I think it’s useful to set out with a simple starting point. Divide the amount of money you have in your pot by 25 and you get the amount that most pension experts would consider a safe enough drawdown rate. So for every £100,000 you’ve saved, you can pay yourself £4,000 pa as extra income.
If you want more than £4000 pa then you are pushing it, you may not be able to adjust your income in future years to keep up with inflation and you could fall foul of what experts call “sequential” risk, when your pot is ravaged by a sharp decline in stock markets and does not recover.
One way of making that £4000 pa a little more palatable is to make sure it is paid to you tax-efficiently. I mentioned earlier (for those with need of cash today) that you can take up to a quarter of your pot as tax-free cash. If you need the money now, take it now. But if you don’t need the money, then keep it in your pension fund and you can drawdown the tax free cash in the early years and only take taxed income later on (when your top tax-rate may be lower).
Another way of making sure that your income is higher, is to stack your pot with contributions from cash you don’t need.
You can pay up to £40,0000 pa or your taxable income – whichever is the lower, to boost your pot. You get tax -relief on all your contributions and the money is invested in a tax-efficient fund. Stacking contributions in your pension fund in your final years of work is a good plan if you have cash in the bank not working as hard for you as it should.
Unfortunately, the amount reduces from £40,000 to £4000 as soon as you have drawn money from your pot, so hands off your pot if you are considering stacking!
4% is only a starting point
A lot of people will take a view that they can draw down at much more than 4% and get away with it. They may well be right, most of us will start drawdown before we get our state pension and drawdown at a higher rate as what experts call a “bridging pension”. Once you’ve started getting your state pension you can drawdown at a lower rate and get back on track. Other people will consider inheritances as a similar windfall in future years. Some will deliberately run down their income to avoid the threat of being means-tested out of social care benefits (though you should read the rules on deprivation in Age UK’s fact sheet).
Second rule of thumb – For heaven’s sake – stay invested.
When you start drawing down your pension , you begin a process that could last 30 years or more. It is not something that stops when you are 60 or 70 or even 80. So it makes absolute sense to be invested for the future when you start. Do not move all your pot into a cash fund, this may sound the safe thing to do , but it is the opposite, it will mean that you are stuck with virtually no growth on your savings meaning that you will run out of money later on.
Putting your money in cash is not even guaranteeing you your money back, most cash funds you can buy can go down as well as up and what is almost certain is that the cash fund will not return you the rate of inflation so in real terms , the value of your cash fund will fall. If you are planning on losing out from your investments for 30 years, then go for cash at outset, but you will probably look back and call yourself a muppet.
Third rule of thumb – keep costs down
To keep your money in a pension drawdown fund, you don’t need to be paying away a lot in fees. Remember that 1% of £100,000 is £1000, a lot of money every year. You should not be paying more than 1% each year for your drawdown pot and you should only pay advisers on top, if you feel you really need their advice.
One way of keeping your costs down is to shop around and find the best drawdown provider. There isn’t a lot of good comparative advice out there at the moment (and frankly most of the drawdown plans are far too expensive). Probably the best place to start looking is Which? – the link’s here.
The Which table is ok as far as it goes, but it only tells you what you will be paying for the drawdown service (the platform), you have to pay again for the funds which will at least double the platform fee.
If you want to pay an adviser, expect to pay around 1% pa for the first £100,000 of your pension savings pot (less for more). If you have a small pot, you probably won’t find an adviser who will be able to help you.
You will probably find -if you want to stay within a 1% budget that you need to go on a non-advised platform and use the support of the platform. I find Pension Bee and E-vestor the kinds of organisation geared for your needs.
It may be worth waiting for the market to improve, the big workplace pensions like NEST and People’s pension may well open up for drawdown in years to come and it’s likely that there will be more competition from existing pension providers when they do, for now the market looks weak and consumers look like they are generally getting poor value. That’s why the FCA are looking at capping the amount a drawdown manager can charge a customer in drawdown.
Fourth rule of thumb – choose your drawdown investment wisely.
I really don’t see why people who could not choose their own investment funds when saving for a pension, can suddenly be expected to make choices when spending their pot.
But because most of the large workplace pensions don’t offer a satisfactory drawdown option (yet), people are having to move to self-invested personal pensions (SIPP) to drawdown which (by definition) don’t make the investment decisions for you.
I’m sure this will change but for now, if you are investing in a SIPP, then you should look at a fund that is within your budget (I suggest 1%). Remember you have to pay platform fees and transaction costs (see the Which report) so your fund budget is unlikely to be much more than 0.4% and that will restrict you to investing in a passive fund or perhaps something called Smart Beta – which might tilt your investment towards sustainable investments or a more diversified approach than just a single stock market index. Generally speaking diversification is good so if you can get a fund that invests in shares (UK and overseas) , bonds and perhaps a little in other things (alternatives) for 0.4% – that may be your best option.
You want your investment fund to give you as smooth a ride as possible and diversification is a good way to get that smoothness.
Fifth rule of thumb – take your time
If you’ve got this far in one of my longest ever blogs, you are probably pretty interested in this subject and I suspect that’s because you have a personal interest.
I’ll declare my hand, I’m hoping that AgeWage will be able to help people like you to turn pots into pensions and I expect to draw upon the ideas in this blog when we launch the AgeWage blog later in the year.
I’m having to take my time in this – not least because I will need the buy in from the FCA and other regulators to help people with the kind of guidance they need to turn their pots into pensions.
It took me nearly 10 months just to get all my pots in one place. It is taking me as long to research my drawdown options and I’m still not sure of what to do.
Can I help?
As far as I know, I’m about the only person who is actually trying to set up an app for people to learn about this stuff and take practical steps to organise their affairs to convert pots into pensions.
If you found this blog helpful, please contact me on firstname.lastname@example.org and we may be able to set about working with each other!