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Turning your pension into an income

James Daley - Fairer Finance founder and Managing Director.

James Daley

Money expert and Founder of Fairer Finance

Last updated 15th April 2020

7 min read

When you reach retirement, the first and most important financial task you need to deal with is turning the money you’ve saved in your pension into a regular income.

What to do if you’ve got a
defined benefit

If you’re lucky enough to be a member of a defined benefit pension scheme (also known as final salary, or career average pension scheme) then you may not need to do anything.

You’re likely to have a defined benefit pension if you worked or work in the public sector – for example, as a civil servant, for a school or in a hospital. Some large companies also still offer defined benefit pension schemes. If you’re not sure what type of pension you have, check with your employer.


How defined benefit schemes work

Defined benefit schemes automatically start paying you a regular income when you retire – and carry on paying it until you die. How much you get is based on how long you were a member of the scheme, as well as what you were earning when you retired (or what you earned on average across your career).

Because these pensions pay out a regular amount until you die, they tend to be worth hanging on to. If you live for 40 or 50 years in retirement – as some people do these days – that regular income could add up to a substantial sum.


Defined benefit considerations

While you sometimes have the choice to transfer your money out of a defined benefit scheme – it’s usually a bad financial decision, as you’re unlikely to get back as much as you would have done if you’d stayed part of it.

Beware of scammers trying to persuade you that they can get you a better deal by transferring your money out of a defined benefit scheme. Even with the incentives that some schemes offer, it’s unlikely to be a better deal.

Nevertheless, defined benefit schemes are not completely risk free. If they are offered by private companies, then there needs to be enough money in the pot to keep the promises that were made to pensioners.

In some cases, companies have gone bust leaving large holes in their pension scheme. And while the government’s pensions protection fund will ride to the rescue in these situations, it will only guarantee 90% of your pension, up to a maximum of around £40,000 a year.

If you do decide to transfer your money out of a defined benefit scheme, make sure you get financial advice from a reputable independent financial adviser. Ideally, look for someone with the Pension Transfer Gold Standard accreditation.

What to do if you’ve got a regular save and invest pension

If your company doesn’t offer a defined benefit pension, then your pension will be what is known as a “defined contribution” or “money purchase” pension. This means that you save a fixed amount every month – usually topped up with some extra from your employer - and the money is invested in stocks and shares.

If you’re part of the growing numbers of people who have one of these pensions, then you have more choices to make when you retire. Unlike a defined benefit scheme, your pension won’t automatically convert into an income for the rest of your life.

Instead, you’ll have a pot of money and it will be up to you to decide how to use it to provide the income you need.

Buying an annuity

If you want the certainty of knowing what your income will be for the rest of your life, then you could consider using your pension pot to buy an annuity. This is a financial product that provides a regular income until you die.

The upside of annuities is that they give you the certainty of knowing what money you’ll have. The downside is that in today’s low interest rate environment, the rates of return you can get on annuities are not as attractive as they used to be.

Annuity options

If you do decide to buy an annuity – you can either opt for one that pays you the same amount every month for the rest of your life, or you can opt for one that increases its payouts with inflation.

Buying yourself protection against inflation is a worthwhile investment, as if you live a long time, you will find that your fixed income stretches less far each year.

However, if you opt for an annuity that increases each year with inflation, you’ll get a much lower rate at the outset.

You may be able to get higher rates if you have a health condition, or you’re a smoker. These can be around 10% more for a smoker, and much higher for people with serious health conditions.

There are a few other options to consider when you’re buying an annuity. For example, if you have a partner, you may want to buy an annuity that carries on paying out after the first person has died.

Or you may want to guarantee that your annuity pays out for a fixed period of time regardless of when you die.

It’s important you get independent financial advice before you decide which option to go for. Once you’ve bought an annuity, you tend to be locked in for the rest of your life – so it’s vital you’ve made the best possible decision for your circumstances.

Keeping your pension invested

Buying an annuity is not the only option for generating an income in retirement. You can also choose to keep your pension invested, and draw down what you need gradually over time. This is known as pension (or income) drawdown.

Pension drawdown

The advantage of pension drawdown is that you can potentially benefit from continued investment growth on your pension pot. The downside is that by continuing to leave your portfolio exposed to the ups and downs of the market, you won’t have the same certainty over your income that an annuity can give you.

Pension drawdown allows you to take out as much as you like from your pension – so if you’re not careful, it’s possible to take out too much in the early years, and not leave yourself enough to maintain your lifestyle in the later years of retirement.

But on the plus side, drawdown gives you greater flexibility than an annuity – allowing you to increase your income when you need it, and to reduce it when you don’t.


Considerations with pension drawdown

As with buying an annuity, if you’re looking at income drawdown you should consider getting professional independent financial advice – to ensure you’re keeping your costs to a minimum and investing your money in the right assets.

You’ll typically have to play a platform fee to the company where your money is kept. And there may be additional charges for setting up drawdown, or for adding extra money into your pot after you’re retired.

Beyond that, you need to keep an eye on the costs of the funds that you’re invested in. There is an enormous variation in the solutions on the market – with some charging fund management fees of well over 1% a year, while others charge little more than 0.1%.

These fees can add up over time and can have an enormous impact on the potential returns that your portfolio will make.

What the government will give you when you retire?

As long as you’ve worked in the UK for most or all of your adult life, you’ll qualify for a state pension when you retire.

You need to have paid national insurance contributions for at least 10 years to qualify for any state pension, and at least 35 years to get a full state pension. However, these years don’t need to have been consecutive – and you can also get credits if you were unemployed, sick or a parent or carer.

The full state pension is £175.20 a week in 2020/21 – and rises every year. If you don’t qualify for the full amount because you haven’t got enough years of credits – you can buy these by making voluntary contributions.

The age at which you get your state pension has been rising in recent years. Currently, you can start claiming your state pension at 66. For anyone retiring after 2044, that will have increased to 68 – and there may be further increases.

If you’re fit and willing to carry on working, you can increase the amount of state pension you get by holding off and not starting to claim it for a few years.

Claiming pension benefits

If you’re already retired or need to retire – and you haven’t got enough national insurance credits to get a full state pension – you may be able to top up your income with pension benefits.

If you qualify for pension credit, your income will be topped up to close to the level of a full state pension.

If you’re not physically fit – and you need support with your daily living – you may also qualify for additional benefits such as attendance allowance.

You can find more about which benefits you qualify for on the gov.uk website.

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Here's the information that you need to know about who we are and the other companies that we work with in order to provide our products and services.

Who are SunLife and who provides the SunLife Guaranteed Over 50 Plans?

SunLife Limited distributes financial products and services , registered office: 1 Wythall Green Way, Wythall, Birmingham, B47 6WG, United Kingdom (registered in England and Wales, no. 05460862). SunLife Limited is authorised and regulated by the Financial Conduct Authority and is entered on the Financial Services Register (registration no. 769427).

Phoenix Life Limited trades as SunLife and is the provider of the SunLife Guaranteed Over 50 Plan life insurance policies. Phoenix Life Limited’s registered office is at 1 Wythall Green Way, Wythall, Birmingham, B47 6WG, United Kingdom (registered in England and Wales, no. 1016269).

Who provides the Funeral Benefit Option?

If you choose to add Funeral Benefit Option to your Guaranteed Over 50 Plan, Dignity Funerals Ltd arranges and provides the funeral services, registered office: 4 King Edwards Court, Sutton Coldfield, West Midlands, B73 6AP (registered in England and Wales, No. 00041598). Dignity Funerals Ltd is a member of the National Association of Funeral Directors.

Who provides the Funeral Plans?

Dignity Funerals Ltd arranges and provides the funeral services, registered office: 4 King Edwards Court, Sutton Coldfield, West Midlands, B73 6AP (registered in England and Wales, No. 00041598). Dignity Funerals is not authorised or regulated for this activity by either the Financial Conduct Authority or the Prudential Regulation Authority. Dignity Funerals Ltd is a member of the National Association of Funeral Directors.

The life insurance policy that pays for your funeral will be provided by Phoenix Life Limited, trading as SunLife.

Who provides SunLife Pet Insurance

SunLife Pet Insurance is arranged and administered by BDML Connect Limited. BDML Connect Limited is authorised and regulated by the Financial Conduct Authority (No. 309140). Registered in England and Wales Number 02785540. Registered Office: 45 Westerham Road, Bessels Green, Sevenoaks, Kent, TN13 2QB.

Who provides SunLife Home Insurance

SunLife Home Insurance is arranged and administered by BISL Limited and underwritten by a panel of insurers. BISL Limited are an intermediary authorised and regulated by the Financial Conduct Authority. Registered in England no. 03231094. Registered office Pegasus House, Bakewell Road, Orton Southgate, Peterborough PE2 6YS.

Who provides SunLife Car Insurance

SunLife Car Insurance is arranged and administered by BISL Limited and underwritten by a panel of insurers. BISL Limited are an intermediary authorised and regulated by the Financial Conduct Authority. Registered in England no. 03231094. Registered office Pegasus House, Bakewell Road, Orton Southgate, Peterborough PE2 6YS.