Workers typically undertake a five-year journey to retirement during their mid-60s, research reveals.
Pension freedom reforms give older people greater control over when they retire, and on average they begin to tap their savings at 62 and stop work at 64, figures show.
That means they must use private savings during the gap before starting to draw their state pension at 66 or 67, the milestone that traditionally (if unofficially) marks the start of retirement.
Red letter day: What should you consider when deciding the timing of retirement and preparing your finances for old age?
‘Working till you drop clearly doesn’t appeal to the average UK worker who has plans to slow down in their early 60s,’ says Andrew Tully, technical director at Canada Life, which surveyed some 2,000 adults on their retirement plans.
‘This creates a clear financial planning issue and people need to take positive steps early to mind the pension’s gap, whether that be saving more, moderating their ambitions or considering working longer.’
People approaching retirement can shuffle the order of events depending on their financial circumstances or desire to continue working.
You can also postpone taking the state pension in exchange for higher payouts later, though you cannot bring the date forward.
We look what to consider when deciding the timing of retirement and preparing your finances for old age below.
Source: Canada Life
Road to retirement: Should you tap your pension before stopping work?
Two in five people taking cash from their pension for the first time are still working, and many continue paying into a pension afterwards, according to research by Canada Life.
People who start tapping pots for any amount over and above their 25 per cent tax free lump sum are only able to put away £4,000 a year and still automatically qualify for tax relief from then onward.
Beyond the lump sum, pension cash is also taxed as income, so if you take large sums this can push you into a higher tax bracket.
Canada Life has also looked at how over-55s have used money withdrawn from pension pots. This shows that 36 per cent have put the money in a savings account and 24 per cent transferred it to a bank account.
Financial experts frown on this as people are letting their money get gobbled up by low interest rates and inflation, potentially missing out on future investment growth, and becoming liable for unnecessary tax.
The survey also found 21 per cent of people spent pension cash on holidays, 21 per cent on home improvements and 14 per cent on new cars.
Although pension freedom reforms launched in 2015 allow over-55s to access their entire retirement savings and do whatever they want with them, there’s no requirement to do anything.
But a behavioural study found savers are feeling pressure to use the freedoms immediately when the best course of action is often to do nothing with their retirement pot for now.
Researchers suggested people ask themselves 10 questions before acting, with the list topped by: ‘Do I really need to take any of my pension money now?’ Read the full list here.
Giving up your job and a regular income: When should you retire from work?
‘Retirement is incredibly personal, with the decision to finish work depending on a combination of financial, family, work and health considerations,’ says Nathan Long, senior analyst at Hargreaves Lansdown.
How to invest your pension and live off it in retirement
A 12-step starters’ guide – and the pitfalls to avoid. Read more here.
‘Increasingly we expect to see more and more people move into semi-retirement, gradually reducing their work commitments until they finally call it a day.
‘At the moment people semi-retiring tend to do so because they enjoy work. In the future with lower levels of pension saving, it will become necessity.’
Long offers a couple of tips for sorting out your finances at retirement. First, he says that under current flexible pension rule it rarely makes sense to buy an annuity whilst you are still working and have certainty of income, particularly with rates at low levels.
‘All things being equal, rates improve as you get older and as you age it is more likely you’ll develop health conditions which could boost your annuity payout still further.
‘If you need to access your pension to supplement your earnings because you’ve changed to part-time hours or to being self-employed, then remaining invested and drawing from your pension investments is a sensible approach for most people.’
Second, he says that there can be advantages to deferring state and defined benefit (also known as final salary) pensions because doing so can guarantee higher payouts in the future.
‘The same is not necessarily true of defined contribution pensions, where future payouts depend on how your investments perform and annuity rates if you opt for secure income.’
Patrick Connolly, chartered financial planner at Chase de Vere, says: ‘Many people have unrealistic expectations about when they’ll be able to retire. They don’t understand how much money they’ll need or how long they are likely to live
‘These people are likely to get a nasty wake-up call in terms having to work longer than they hoped, living a more frugal lifestyle in retirement or risking running out of money in their later years.
‘Previously people simply retired when they reached state pension age or when their company pension scheme paid out.
‘However, the demise of final salary pensions and increases in the state pension age mean that most people cannot rely on their employer or the government to give them the retirement that they want.
‘At the same time, the introduction of pension freedoms in 2015 has fundamentally changed how and when people take their pension benefits. For some people the best approach is to leave money in their pension and to draw income from other sources.’
Connolly says that if you want to retire before your state pension age, you should work out if you can generate enough income until it kicks in, and if you will then have enough sustainable income for the rest of your life.
‘If the answer is no, then you need to make a decision of either retiring later or doing extra savings and investments now so that you can get on track
‘Draw up an action plan to achieve your target and review this regularly, taking action if you fall behind your target. If you’re not sure what you’re doing, then take independent financial advice.’
Andrew Tully: ‘Working till you drop clearly doesn’t appeal to the average UK worker who has plans to slow down in their early 60s’
Preparing your finances for retirement: A six-point plan
Andrew Tully, technical director at Canada Life, offers the following tips on smoothing the path to retirement.
1. Make a budget and clear your debts
Make a budget of your likely bills in retirement. Be realistic and think about how you will pay for bills as costs increase over time.
Be honest, account for everything. So council tax, food, heating bills, going out, car insurance.
You may find your income is not sufficient to cover your expenditure. Don’t panic, this is the time to review your needs in retirement and see where you might be flexible, for example, do you really need the gym membership? Or can you consider working longer?
Consider other assets including savings and your property which can help bridge the gap.
Clear expensive debts as a priority.
2. Find out how much income you will have
Work out the income you are likely to receive when you retire. Include the state pension, any personal or company pensions you may have and any other savings.
The first step is to ask for a state pension forecast. With the changes to state pension age, you might find your retirement age is later than you expected, or the amount is less than you thought.
To qualify for the full state pension you need 35 years national insurance record. If your record is incomplete you can choose to top it up while you are still working.
Check for other sources of income, for example a final salary pension from an old employer. These pensions are highly regarded as they guarantee an income through retirement, often linked to inflation.
How to check your state pension
Ask for a pension statement which will show both the tax-free cash and income. You often don’t have to take the tax-free cash and can choose to receive a higher starting income.
You might be saving in a company pension that will provide a pot of cash when you retire which you can use to pay yourself an income or withdraw, subject to you paying tax.
Check if you have any valuable guarantees attached to your pension, for example guaranteed annuity rates. These are highly valuable although there are usually only certain times the guarantees are valid, so check with your pension company.
You can check for free if you think you might have lost track of an old pensions by using the Government pension tracing service.
You can also think about combining old pension schemes so you can more easily keep track of them but always check charges and exit fees before doing anything.
3. Work out how to make your income last
We are all living longer. Which is great, but think about how long you expect your pension to last in retirement. How much of this is guaranteed (for example the state pension, defined benefit pension, or annuity income), compared to other savings you might have.
A man aged 65 today has a 50 per cent chance of living until 89, and a 25 per cent chance of living to 95, while a women the same age has a 50 per cent chance of living till 93, and a 25 per cent chance of living till 97.
Making your pension last as long as you do is probably one of the biggest challenges. You may also face the loss of a partner, or divorce, or the prospect of paying for long-term care. Governments also have the habit of moving the goal posts and changing the rules of the game.
4. Decide which retirement income products suit you best
Consider mixing and matching retirement products, for example annuities to guarantee an income to meet your bills, and income drawdown as your ‘flexible’ savings pot.
How much guaranteed income do you need in retirement?
Follow This is Money’s five-step guide here.
Investing in retirement to generate an income over 20 years or more is completely different to saving for retirement.
Money invested in the stock market can go down as well as up, and if you withdraw cash when stock markets are going down, you might likely never make up your losses.
The FCA has found many people are making poor investment decisions because they simply put the money into cash and could receive 37 per cent more income every year by making proper investment decisions.
You need to work out when to withdraw an income, how much to withdraw and how long you need that income to last. A common rule of thumb is around 3 per cent to 4 per cent a year is OK to withdraw from your pot, but much depends on how your investments perform.
Many people follow the path of least resistance and simply accept the offer from their current pension provider, rather than shopping around for the best product or best rate.
The FCA is concerned people are not always getting a good deal, and that some people could be paying higher charges than necessary.
5. Keep tax in mind
Any pension withdrawals are subject to income tax if you earn more than the personal allowance in any one tax year. This is called your personal allowance and includes state pension, salary if you still work, as well as your pension income.
Once you’ve started taking a pension, you are limited by the tax man to the amount you can continue to save into a pension (restricted to £4,000 a year).
The good news is any unused pension can be passed on to younger generations tax-free if the money is kept in the pension if you die before age 75.
6. Be alert to scams
The pension freedoms have opened the floodgates to conmen who want to steal your money by offering ‘too good to be true’ investment returns, free ‘pension reviews, access to your cash tax free or before the age of 55.
If you are contacted out of the blue, run a mile, hang up, or simply delete the email or the text. No financial company or adviser will make unsolicited contact with you.
TOP SIPPS FOR DIY PENSION INVESTORS
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