Interactive Investor

Five ways to maximise your pension income

7th June 2022 13:36

Alice Guy from interactive investor

Rising bills and inflation are eating away at our hard-earned savings and the cost-of-living crisis is hitting pensioners hard. Alice Guy takes a look at five simple ways to maximise your pension income.

The cost-of-living crisis is affecting all of us, and pensioners are some of the first to feel the pinch. The triple-lock on the state pension was scrapped this year and as a result the state pension grew at a disappointing 3.1%.

In contrast, everyday costs are on the increase. The average energy bill is expected to hit a whopping £2,800 by October. And food bills, council tax and petrol prices are sky high, with inflation currently at a 40-year high of 9%.

It’s a double whammy for pension investors as these increasing costs are hitting at a time of stock market volatility. Many of us are expecting our investments to grow at a lower rate for the next few years and are wondering how to maximise our pension income.

So, are there any practical steps you can take to maximise your pension income? Here are a few ideas.

1) Delay taking a pension

Let’s be honest, delaying taking a pension definitely isn’t possible for everyone. But if you’re weighing up when to retire, and you don’t mind working a bit longer, then delaying a few years could be worth considering.

According to figures from comparison website sharingpensions.co.uk, if you’re planning to buy an annuity, then waiting an extra five years and retiring at 70 rather than 65 could give you an extra pension income of £1,574 per year. That’s based on someone with a £200,000 pot buying a single life level annuity with no guarantee.

And if you plan to use income drawdown to access your pension, then there are even more potential benefits to delaying retirement a few years. You’ll have longer to see your pension pot grow and you’ll be drawing on that income for less time, preserving your pot intact for longer. The longer you leave it to take taxable income from your pension, the longer you can take advantage of the standard annual allowance for pensions of £40,000 or up to your maximum earnings. This is cut to £4,000 a year once you start taking taxable income.

2) Consolidate your old pensions

A recent study showed that the average Briton has six different jobs during their working life. And many of us have old workplace pensions languishing unloved in old, forgotten schemes.

Those old pensions schemes are likely to be charging much higher fees, typically 1%, than you would pay if you transferred your pension to a low-cost SIPP.

Transferring and consolidating your pensions could provide a much-needed boost to your pension pot and income. For example, if you transferred £100,000 from an old workplace scheme with 1% fees, then you could save around £880 per year by using a low-cost SIPP with a flat fee, and at least £16,882 in fees over 20 years.

3) Consider income drawdown

Income drawdown has become an increasingly popular option for investors in recent years. Pension freedoms, introduced in 2015, mean that you can use income drawdown at any age and take as much from your pension in one go as you wish.

Income drawdown could give you more money in your pocket than an annuity income.

Despite annuity rates climbing this year, a modest pension pot of £200,000 would currently only buy an annuity of £7,720 per year (based on an annuity income that escalates 2% per year). That means you would need to live for at least 26 years to re-coup your original investment.

In contrast, income drawdown could give you £9,500 per year (based on 5% annual returns and living until you’re 95 years old). More modest growth assumptions of 4% could leave you with a drawdown income of £8,000.

Income drawdown is also extremely flexible and you’ll be able to choose when and how much you withdraw from your pension pot. If you die with money remaining in your pension, you’ll be able to pass that wealth on to your beneficiaries. In contrast, if you buy an annuity, your pension pot is gone forever.

Of course, there’s also nothing to stop you using a mixture of annuity income and income drawdown, and it could be a great option if you want some security in old age but still want to remain invested. Interestingly, a recent study by pension experts and actuaries LCP showed that annuities may actually become better value and may be worth a look as you get older.

If you’re weighing up which option to pick, then it could be worth talking to a financial adviser and looking in detail at your investment goals, other assets and any tax implications for your choices.

4) Spring-clean your investments

It’s a good idea to review your investments every year as they may no longer suit your requirements. The relatively adventurous portfolio of a 40-year-old may not suit an investor nearing retirement. That’s why many older investors choose to gradually reduce their investment risk and opt for a mixture of equities, fixed income and cash in their portfolio.

It’s also worth taking a look at the performance of your funds to see if there are any you want to ditch. Super-adventurous small company funds are generally doing less well in a low-growth environment than bigger blue-chip, income-generating funds. That’s because their future profits are much less certain than established companies and therefore tend to be more volatile.

5) Minimise your pension tax bill

For investors, the good news is that you’ll be able to take 25% of your pension pot completely tax-free.

But the rest of your pension income will be taxed with income tax, just like any other income. And you could pay capital gains tax on any shares or funds outside your pension and stocks and shares ISA.

This means that planning the order you use your investments could save you tax. For example, using a stocks and shares ISA, alongside your pension income could minimise your income tax bill as your ISA income won’t count towards your personal allowance.

Also, don’t forget that your beneficiaries won’t pay inheritance tax on assets held in a pension. If you die before age 75, nor will they pay income tax on income they take from it. For some investors, with other income and a big potential inheritance tax bill, it could make sense to use other income first and leave their pension pot intact.

If you’re getting older and think you might need to pay inheritance tax, then it’s worth learning more about inheritance tax and getting some tax-planning advice from an independent financial adviser or a solicitor. They’ll be able to look at all your circumstances and make sure you don’t have any nasty tax surprises.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Important information – SIPPs are aimed at people happy to make their own investment decisions. Investment value can go up or down and you could get back less than you invest. You can normally only access the money from age 55 (57 from 2028). We recommend seeking advice from a suitably qualified financial adviser before making any decisions. Pension and tax rules depend on your circumstances and may change in future.