10 Strategies for a Secure Retirement
The rising cost of living is throwing into sharp relief the problem of staying financially secure in retirement. For many, this comes on top of the challenges of waiting longer to get the State Pension and bewildering choices about other pensions since the introduction of ‘pension freedoms’ in 2015. If you’re soon-to-be or already retired, here are my top 10 hacks for a secure retirement.
1. Don’t ignore inflation
While may seem alarming, many of you approaching retirement today will remember much higher rates: 25% in the mid-1970s and 10% in the early 1990s. So, you know that a lot may change over the decades of your retirement and it’s best to be prepared.
The State Pension usually increases each year by at least enough to compensate for rising prices. But many other sources of retirement income don’t. Inflation will eat into the buying power of a fixed income, reducing your standard of living as the years go by (see the example below).
Diagram 1. How inflation could reduce the buying power of a fixed income
Where you have a choice, think about opting for sources of income that offer some protection against inflation. Where your income is fixed, try to set aside some savings to help you cope with higher prices later on.
2. Check your State Pension age
The age at which your State Pension starts to be paid has been increasing for both men and women and is currently 66 years of age. You can check your own State Pension age on the government's website.
If you want to retire earlier, you’ll need to plan how to fill the gap until your State Pension kicks in. For example, do you have cash savings to bridge the gap? Think carefully before withdrawing from your workplace or personal pension early, because this will usually mean a lower pension that will persist throughout retirement.
3. Treasure your pension promises
There are two types of pension scheme you might belong to through work: schemes that promise a specified amount of pension, typically as a fraction of your pay (called ‘defined-benefit’ schemes); and schemes where you build up a pot of savings but cannot be sure how much retirement income it will provide (‘defined-contribution’ schemes).
Defined-benefit schemes are still the norm if you work in the public sector (for example, for the NHS, schools, or local or central government), but they are becoming rare in the private sector.
Your employer may offer you what seems a life-changing sum to give up a private-sector defined-benefit pension, transferring the proceeds to a defined-contribution scheme instead. In most cases, don’t do it! You will be giving up a secure pension, payable for life and typically at least partially protected against rising prices.
If you transfer, your income will depend on the vagaries of the stock market with no automatic protection against investment downturns, inflation or outliving your savings.
4. Understand your options
If you have defined-contribution pensions, you’ll need to decide at retirement how to turn your pension pot into an income. There are two basic options:
- Buy a lifetime annuity. This is a type of insurance against living too long. You use part, or all, of your pension pot to buy a secure income that is payable for the rest of your life. You can choose whether this income is protected against inflation.
- Flexible drawdown. You transfer your pension pot to a drawdown fund where it remains invested (so its value goes up and down with the stock market) and you draw out money as and when you want to.
Which to choose is not easy. Lifetime annuities guarantee a secure income but are expensive. Drawdown might work out better but there is a significant risk that it could do worse.
One strategy is to add together your State Pension and any defined-benefit pensions from work. Do they provide the bare minimum income you could survive on? If not, buy a lifetime annuity to fill the gap, but use drawdown for the rest of your pension pot.
5. Invest for resilience
Deciding how best to invest your drawdown fund to provide a lifelong inflation-proofed income is a challenge, because the future will always be uncertain. Most experts recommend you diversify your savings, spreading them across a range of different assets, so that when some are in the doldrums, others may be doing better.
Guard against having to sell your investments when asset prices are low by having a buffer of cash savings equivalent to two or even three years’ spending.
6. Take advantage of the tax-free lump sum
At the point when start to draw a pension, you can take a quarter of its value as a tax-free lump sum (called a pension commencement lump sum or PCLS). The rest of the savings are taxable at the time you draw them out. (Option 1 in Diagram2)
Taking the maximum lump sum looks like a no-brainer: it saves you tax. But not everyone needs a large lump sum and taking it reduces the amount of pension you get. For example, you might have planned that a £100,000 pension pot could provide a steady income of £4,000 a year. But, if you take a quarter of the pot (£25,000) as a tax-free lump sum, the remaining £75,000 would provide only £3,000 a year income.
However, with defined-contribution schemes, there are some ways to get the tax-free cash without reducing your income, for example:
- Uncrystallised Funds Pension Lump Sum (UFPLS). This ugly name simply means that you keep your pension pot in its pre-retirement state but draw out part as a lump sum (provided you’ve reached age 55, increasing to 57 from April 2028). A quarter of each sum you draw out is tax-free and the rest taxable. So, if you draw out £4,000 a year, of this £1,000 is tax-free and £3,000 taxable. (Option 2 in Diagram 2)
- Phased retirement. Each time you want some ‘income’ you convert just part of your pension pot into a flexible drawdown fund. You take the PCLS for just that part and put the rest into a drawdown fund where it remains untouched until you need it later. For example, you could convert £16,000 from the pension pot. A quarter (£4,000) would be the tax-free lump sum, which you would use as income. The other £12,000 would go into the drawdown fund. (Option 3 in Diagram 2)
Diagram 2: Three ways to access the tax-free lump sum from a defined-contribution pension scheme
7. Decide if you need your pension yet
If you’ve reached State Pension age but you’re still working, your State Pension may be pushing you into a higher tax bracket. Think about deferring your State Pension (or cancelling it if it’s already started). As well as saving tax, the pension will be bigger once it does start to be paid.
For example, from April 2022, the full State Pension will be £185.15 a week. But if you deferred it for a year, it would be increased by 5.8% to £195.89 a week (with the new amount inflation-proofed and paid for life).
Deferring to get a bigger eventual pension often works for workplace and personal pensions too.
8. Make money from your home
There are tax allowances that help you to make money from your home. The Property Allowance lets you have up to £1,000 of income (before expenses) from using your home without having to declare it or pay tax on it. This could cover, for example, hiring out your driveway as a parking space or occasionally renting out your home as an Airbnb holiday let.
If you have space to take in a lodger, you can have an income of £7,500 a year tax-free through the Rent-a-Room-Relief scheme.
If you’re a 65-plus homeowner, equity release is a way to draw out the wealth tied up in your home without having to move. Not for everyone, it’s essential to get financial advice before going down this route and wise to choose advisers and providers who belongs to the Equity Release Council which operates a code of good practice.
9. Think green and save
Especially with energy prices so high and expected to increase further from April, you may currently be feeling that your home, rather than being an asset, is more of a drain on your finances.
Some simple low-cost ways to cut your energy usage and bills include fitting draught-proofing strips around doors and windows and switching to LED lighting (each could save £30 a year according to the Energy Saving Trust), spending 4 minutes less in the shower (saves £45 a year) and turning off appliances rather than using standby mode (saves £40 a year). You’ll also be lowering your carbon footprint!
10. Seek financial advice and be alert to scams
At the point of retirement, you might be the richest you have ever been. But that wealth has to support you for a long time, so you’ll need to manage it wisely.
There is lots of general guidance on the government-sponsored MoneyHelper website. From time to time, you may need the help of a financial adviser – I recommend using the MoneyHelper Retirement Adviser Directory to help you find one.
Finally, bear in mind that retirement savings are a magnet for fraudsters. Be on the alert and remember: if a deal sounds too good to be true, then it is and you should avoid it. Check out the advice on the financial regulator’s ScamSmart website for ways to protect yourself.
Life is always full of surprises, but these 10 strategies will help to put your finances on a sound footing and improve your chances of a happy and secure retirement.