The quality of your pension planning during your working life will have a huge bearing on your income when you retire.
But, as you approach retirement, there are some important financial decisions that can also affect your standard of living.
1. Retirement can last a long time
Although you may have saved towards your retirement pot for the last 20 or 30 years, don't treat it as the end goal.
Average life expectancy at age 65 is 83.5 years for men and 86.1 years for women in England and Wales, with the number of people living beyond 100 increasing five-fold in the last 30 years. This means you could easily spend as long in retirement as you did saving for it.
Factoring this into your retirement investment strategy could enable you to take more risk with your money. For example you might want to set up a portfolio that includes low-risk cash and fixed interest to generate income in the short term, with higher-risk equities that will grow and provide your income over the longer term.
Additionally, if you're considering an annuity, you might want to opt for one that is at least partially index-linked. Although you'll start with a lower income level, this will help your pension income stay more in line with inflation over the next 20 or 30 years.
2. Annuities, and alternatives
As you near retirement your pension provider will offer you the option to switch your fund for an annuity, which will pay you an income for the rest of your life. But major changes to the pension regime in the 2014 Budget are doing away with the obligation to buy an annuity, and opening up the likelihood of a variety of alternatives to traditional annuities emerging into the market.
The changes mean that if you retire after April 2015 you will have far more freedom of choice over what to do with your pension pots, including being able to take out as much or as little as you want.
Instead of paying a high tax penalty to cash in your pension pot, after age 55 you will be able to take out as much of it as you want, subject only to income tax on three-quarters of your money. You will be able to spend or invest this money any way you see fit, but keep in mind that once it’s gone, it’s gone.
Those who are retiring before April 2015 but want to keep their options open, given the changes and likely new products expected as a result of the new regime, can also do so.
They can opt to take their 25 per cent tax-free lump sum, but leave the rest of their pension fund invested for up to 18 months (previously there was a six-months time limit before they had to decide between an buying an annuity or income drawdown).
Alternatively, they may prefer the flexibility of an income drawdown plan, where the money is left invested and an income drawn directly from it. Further far-reaching changes announced in the Budget mean income drawdown can now be accessed by a wider range of people at retirement.
If you do decide to opt for the security of an annuity at this stage, there's no need to feel any loyalty to your pension company; by shopping around in the open market, you could increase your income by as much as 30 per cent simply by going to a different provider.
You could also bump up your annuity rate further if you qualify for an impaired life or lifestyle annuity. This could be something as serious as having cancer or kidney disease or a common condition such as high blood pressure or type 2 diabetes.
It's important to make sure you choose the right type of annuity. Common options include escalation, either at a fixed percentage or in line with inflation; joint life, where the annuity continues to pay out to your spouse if you die before them; and guarantees, where the annuity is paid for a set period even if you die prematurely. There are also fixed-term annuities, which can last for anything from three to 20 years.
3. Healthcare cost hikes
If you've been used to private healthcare through a medical insurance policy during your working life, expect to see the premiums increase significantly once you reach retirement.
Adding a cost control mechanism such as an excess, where you pay the first portion of a claim, or choosing an NHS-linked plan, where you receive treatment only when the NHS waiting list is longer than say six or eight weeks, can reduce your premium.
You might want to reduce your benefits, perhaps streamlining your cover so it only picks up the bills for expensive in-patient treatment. Add in a healthcare cash plan and the cost of consultations will be covered, as well as everyday health expenses such as a trip to the dentist or a new pair of glasses.
Do be careful if you want to switch insurers to take advantage of a cheaper deal. By doing this you could lose cover for any ‘existing’ conditions (those for which you have already had treatment).
It's also possible to pay for treatment as you need it. Many of the private hospitals are happy to negotiate deals, or you could use a service such as Medical Care Direct that does the haggling on your behalf.
4. Taxing times
Tax isn't just an issue for the employed and, although you might receive a slightly higher personal allowance if you were born before April 5 1948, the taxman will still scrutinise every penny of your income.
But, as it's increasingly possible to flex your income in retirement, you may be able to avoid a large tax bill. Income drawdown schemes allow you to turn your income on and off, which may be useful if you're set to receive income from another source, for example consultancy work or rent from a property.
Tax-free investments such as Isas and NS&I savings certificates can also help to reduce tax liabilities. If you've used all these allowances you could also consider switching from income-producing to capital growth investments and drawing capital to boost your cash flow, thereby using your capital gains allowance rather than adding to your income tax bill.
You can also use your spouse's allowances. Sharing income and investments between you, rather than keep it all in one person's name, will allow you to use both allowances and reduce your overall tax bill.
5. Using your bricks and mortar
For many people in retirement, the home is their biggest asset. But it is possible to tap into the value of your bricks and mortar to supplement your income.
Downsizing is the most cost-effective way to do this. Although there are costs - and hassle - involved moving home, you will be able to access the full difference between the prices of the two properties.
If you don't want to leave your home, equity release may be worth considering. There are two types of schemes available - a lifetime mortgage, where a fixed rate of interest is charged against the amount you release, or the less common option, a home reversion scheme, where you sell all or part of your home.
Although both will provide cash and enable you to stay in your home for life, you will pay a premium for this. On a lifetime mortgage, although you'll never end up in negative equity, the interest can compound and swallow up the total value of your home.
Meanwhile, on a home reversion scheme you won't receive the full value of the property when you sell it to the provider and, if house prices rise, you'll miss out on this too.
Rather than sell up, you could use your home to generate an income. If you're happy to have a lodger, the rent-a-room scheme may be an option. This lets you earn up to £4,250 a year tax-free by letting out furnished accommodation in your home.
6. Delaying pension is an option
Just because you've reached retirement age it doesn't mean you have to draw your pension. If you can afford to delay tapping into it, you may benefit from further investment growth, as well as a higher rate on an annuity (as a result of age, but also perhaps because of health problems) if you decide to take that route.
State pensions can also be deferred, giving you the option of extra pension income or a lump sum. For every five weeks you defer you'll be entitled to a 1 per cent uplift in your state pension, equivalent to an increase of 10.4 per cent if you wait a year. Wait at least 12 months and you'll be able to take the extra as a lump sum, with interest added at 2 per cent above the Bank of England base rate.
We make every effort to ensure our beginner's guides are kept up-to-date. However, in the constantly shifting environment of investment and financial services, occasions may arise where elements of a guide become out-of-date. Please double-check the facts before taking any important financial decisions.
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