What to do with your pension in your 50s

As you enter your sixth decade you will be getting closer to retirement, meaning you will be planning for it and thinking about when and how to take a retirement income. Here are the main things you need to think about with pensions in your 50s.

Accessing your pension

If you’re aged 55 or over then you have the option to access your defined contribution pension pot, with 25% of it 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 start taking out your pension money, the longer it will potentially have to last for in retirement – and if you draw too much too soon, you 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 has a £100,000 pension and needs to take out £5,000 a year to support their lifestyle, with the income going up each year in line with inflation of 2%.

If they achieve investment returns of 4% after charges, their fund will last around 25 years. For someone taking an income from age 55, that means they risk running out of money by the age of 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, which might not be enough for their lifestyle. Assuming life expectancy in the UK continues to rise there is a decent chance someone in their 50s will live well into their 90s.

These figures are just an example, the reality will differ depending on the size of someone’s pension, their other income sources and their own life expectancy. However, it’s worth highlighting the perils of taking too much from the pot at a younger age.

Tax consequences

You should also consider the impact taking money from your pension will have on the tax you pay. If you opt for big withdrawals – or even 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 also reduce the amount of income tax you pay.

Anyone taking taxable income from their defined contribution pension also needs to be aware of the impact of something called the ‘money purchase annual allowance’. This is where the amount you can pay into your pension each year is reduced if you’ve already accessed the money in your pension. If you access even £1 of taxable income flexibly from your pension, your annual allowance will be lowered from £60,000 to just £10,000.

On top of that, you’ll lose the ability to carry forward unused pension allowances from the three previous tax years. At worst, the money purchase annual allowance will reduce your total available allowance in the current tax year, inclusive of carry forward, from £200,000 to £10,000.

Note that you won’t trigger the money purchase annual allowance 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 withdraw all the money from 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 combining your pensions

As your retirement edges closer, you might want to track down any old pensions you have and combine them with a single provider. The Government’s pension tracing service is a good place to start, and in the long term there are plans to build pensions dashboards which could allow you to see all your retirement pots in one place online.

There are many good reasons to combine your pensions. 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 lots 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. For example, some older-style pensions have valuable guarantees attached that 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. Check out more information if you're wanting to combine your pensions.

Get your investments in order

If you’re planning to access your pension in the next five 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, may 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.

If you didn’t do this you could experience a poorly timed drop in stock markets that has a dramatic impact on your pension pot, as markets can be volatile, particularly over the short term.

If you’re planning to stay invested in retirement and draw an income from the pot, it’s worth reviewing your investments as you approach retirement. This may not necessarily mean you have to make a big change but it's worth checking you're still happy with your investments and the level of risk in your portfolio.

The tapered annual allowance

While most people enjoy a £60,000 pensions annual allowance, higher earners face a smaller limit. There are two different measures of income, and you must earn more than £200,000 (threshold income) in one measure of it and more than £260,000 (adjusted income) in another. 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.

Anyone who exceeds these limits will have their annual pension allowance reduced by £1 for every £2 of adjusted income earned above £260,000, to a minimum of £10,000 for those with adjusted income of £360,000 or more. If you breach your allowance the taxman will come for any tax relief you have received over and above your annual allowance.

You can find out more information here to see if you breach the limits.