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Every week, Kyle Caldwell and guests take a look at how the biggest stories and emerging trends could affect your investments, with practical tips and ideas to help you navigate your way through. Join the conversation, tell us what you want us to talk about or send us a question to OTM@ii.co.uk. Visit www.ii.co.uk for more investment insight and ideas.
Hello, and welcome to On The Money, a weekly podcast that aims to help you make the most out of your savings and investments. Before we start off, just wanted to say that we'd love to hear from listeners. So if you have a pension or investment question that you would like one of us to tackle, or you have an idea for a investment or a pension topic that you would like us to cover on the podcast, then do get in touch. You can do so by emailing otm@ii.co.uk. Now the focus of this episode is one that we think will hopefully resonate with a lot of our listeners.
Kyle Caldwell:We're gonna be talking through top tips and tactics ahead of retirement in regards to how your pension is invested. And joining me to tackle this topic is Craig Rickman, who is personal finance editor at Interactive Investor. Craig, great to have you back on the podcast again.
Craig Rickman:Great to be back on, Kyle.
Kyle Caldwell:So, Craig, the way you've approached this is you focused on hypothetical scenario of someone being around five years away from retiring. And in total, you've come up with seven tips to help people get ready for retirement. So the first one is to firm up your retirement plans. So how does someone even get started in that scenario? How do they practically firm up their retirement plans?
Craig Rickman:Yeah. Sure. Well, I think that probably the first thing is is the the sort of the the five year point. You know, when you're when you're five years from retirement, obviously, it's, it's edging closer. But there's also time to to put things right if you are if there's a is a shortfall in in terms of the savings that you have compared to where you need to be, you've still got a bit of time to make the necessary tweaks to get yourself in the place where you can retire on on your own terms.
Craig Rickman:But, yeah, when when you get sort of five years from the point that you're looking to retire, then your your plans for retirement or your plans for when you're packing up work really need to to start to to firm up. Your your your focus needs to sharpen, and it's really drilling down into, you know, what what you want your retirement to look like. You know, what are the things you wanna do? How much are those things likely to cost you? Is your preference a hard stop from retirement or to to phase in gradually over a number of years?
Craig Rickman:Perhaps continue to work part time in in retirement. There's no one size fits all to it. Everyone gets to, you know, select the the retirement that they want and and, you know, retiring on your own terms obviously means means different things to different people. It's a personal thing. But, yeah, that's five years is the point where you, you know, you you really start to, you know, gather have a have a real clear view of of of what you want your retirement to look like.
Kyle Caldwell:And in terms of working out how much you've currently got in your pension when you're around five years away from retiring, it's a case of simply going through each pension you've got. And some of them, you might have to track down, and you can use services like the pension tracing service, which can be very useful in in order to track those pensions down. And then work out, okay. This is what I've got in the pension, and this is where I want to get to to ideally have x amount to live off in retirement or to to use to fund your lifestyle in retirement.
Craig Rickman:Yeah. Absolutely. Yeah. Yeah. I mean, that's the that's one of the key things is to round up the all the savings that you plan to use for retirement.
Craig Rickman:So, typically, that will be pensions or that will be the largest pot or pots because of people get pensions through their through their workplace, have done since auto enrollment, but also, you know, long long before that as well. So it'll be rounding up any pensions that you have, any savings, any investments. And like you say, making sure you know where they are and you know how much money you've got to to sort of help you live that the the retirement that you want. But, yeah, you know, as as again, as you say, some of these might need tracking down, and you can use the pension tracing service. You can also contact old employers.
Craig Rickman:I mean, that's a really, really useful exercise to track down these pensions, especially if if there are some that you've forgotten about. It can be quite a nice surprise to to, you know, find a pension that you you perhaps didn't think existed. And in some cases, if these pensions are old, they they might be worth quite a bit of money, especially if they've had time to to compound over the years. So, yeah, it's you know, that's that provides the the, you know, really key yardstick of of where you are before, you know, you you edge towards retirement and can inform some of the key decisions you make over the next five years.
Kyle Caldwell:And tactic number two that you've come up with, Craig, is that once you've rounded up all your pensions is to consider consolidating those pensions. So for me, the main benefits of consolidating is that it's easier to manage. It's all in one place. And, also, another benefit is that you can end up paying less through consolidating. Is there anything fair that's adds to those points, Craig?
Craig Rickman:No. That's that's absolutely right. I mean, consolidating can be a a really worthwhile exercise just getting several pensions and and putting them together under one roof roof. Like I say, it make just makes things easier to manage. You can have a very clear view of of what that pot may provide, especially if you sort of punch those, that, you know, the the the figures or the pot sizes into pension calculators and and, you know, against the, you know, the the the level of or the the size of the pot or the level of income that you might want in in in later life.
Craig Rickman:So rounding them up can be helpful with It can also be a really good way to manage investment risk as you approach retirement. So I think we'll we'll we'll certainly be coming on to that. But you can make some of the key decisions on on how you manage risk in those key years before you approach retirement. But there's there's also when when when you're looking to consolidate, there are some things to to to watch out for. Some pensions may contain some some valuable guarantees that would be lost if you switch them.
Craig Rickman:One example would be guaranteed annuity rates on retirement annuity contracts. These are kind of old pension schemes. These they were from from the eighties. With newer pension schemes, any kind of guarantees or valuable benefits are unlikely unless it's a defined benefit pension scheme. But in terms of defined contribution, they typically apply to older schemes.
Craig Rickman:But it but either way, it's worth checking that that they that you're not gonna lose anything really valuable by by switching.
Kyle Caldwell:The next tip that you've come up with is to look beyond pensions. So you may have ISAs, and you also need to factor in the state pension. Obviously, if you retire, say, in your late fifties or early sixties, you're not gonna get the state pension at that point, but you will in future. And you, you know, you can you can plan accordingly to factor that in at a later stage.
Craig Rickman:Absolutely. Yeah. So this this the state pension is is is a really important source of retirement income for basically everyone. From April, it's going up to the full state pension. The full new state pension is going up to around 12 and a half thousand pounds a year.
Craig Rickman:So it's a, you know, it's a it's a really, really important source of retirement income to meet day to day costs. So, yeah, as you approach retirement, it's worth getting a state pension forecast to check that you're on track to get the full amount. You need thirty five years worth of qualifying national insurance contributions or credits. If there are any gaps in your records, you might be able to plug them by by making additional National Insurance contributions. So, yeah, that's that's a that's a really important thing to check and and to get the full amount.
Craig Rickman:You know, your retirement lifestyle will thank you if you do that. But then again, yeah, any other any anything anything else that you plan to to use for your time, that could mean stocks and shares ISAs. It could mean buy to let properties. You could have cash savings. You could have own own a business that you're perhaps looking to sell or pass down to younger generations and have some involvement with.
Craig Rickman:So that's the point. You're looking at everything. You're looking at all the the the sort of the sources that you plan to generate retirement income from, and then that's the point where you're then sort of looking to to make sure that you've that you've accounted for them by the time you reach retirement.
Kyle Caldwell:And I appreciate this is a big topic that we could probably do, like, the entire podcast on. Where do you sit on the debate between ISAs and pensions in terms of which one would you look to withdraw from first?
Craig Rickman:Yeah. That's that's a big question. And in fact, the the considerations around that have have have changed recently, in light of, the government's decision to bring pensions into the inheritance tax net from April 2027. So historically, people would look to draw or maybe even currently to to some extent, we'll look to draw from ISIS first. The main reason being is that pensions are inheritance tax free, so, you know, it's it could be quite a a useful estate planning tool if you're draining the ISA money first and then and then leaving the pensions, yeah, to to be inheritance tax free.
Craig Rickman:But in light of the the new changes, that appears to be reversing. So people are looking to perhaps draw pension income first and leave ICEs untouched. I think that so those are decisions that you can sort of park for the for the time being if you're five years from retirement. But it does tap into a crucial point of of having sort of, you know, you know, multiple tax tax wrappers when you get to retirement. So having money in a pension and also having money in an ISA can just just it just broadens your options and how you draw retirement income.
Craig Rickman:I mean, income is other than the the amount that you can draw tax free, which is either normally 25% up to a maximum of $268.02 $7.05. So anything else is is taxable. Doesn't necessarily mean you'll pay tax because everyone gets a personal allowance, tax free allowance. But ICE withdrawals are tax free. So it it it just means that you can you've you've you've got, you know, plenty of options on how to draw income and and and keeping tax bills low in retirement is a really important thing to do.
Craig Rickman:So, you know, that's another thing to, yeah, to get ready as or get or get ready within your portfolio as you approach the point that you plan to pack up work.
Kyle Caldwell:So once you've rounded up all your pensions, considers potentially consolidating your pensions all into one place, what happens in a scenario where you you look at how much you've got and you think, oh, dear. I'm, you know, I'm I'm quite a bit off where I wanna be. Ideally, there's quite a considerable gap between the amount I've my pension today and the amount I'd ideally like when I retire. What are the ways that people can try and address that gap, Craig?
Craig Rickman:Yeah. Good question. So there are a few. One is to delay your retirement, push it back to give your savings more time to grow and give you more time to pay money in. And that sort of leads us to the the second one there is to, you know, just to beef up your your pension savings.
Craig Rickman:So, again, this this goes back. That's why it's it's it's really important to look at this when you're few years out from retirement because you've still got time to top up. It might be topping up your pensions. It might be other assets like ISAs, for example. But you can start to, you know, give your savings, you know, a shot in the arm before you before you either buy an annuity, go into drawdown, or or do a bit of both.
Craig Rickman:And, you know, those the the years before retirement, you're you're typically earning earning good money or as or as much money as you would have earned in your career unless you've started to take a bit of a backseat. And so so, you know, in that example, if you're earning lots of money and you're paying lots of tax, that's where pension funding is can become key because you get upfront relief at your at your marginal rate. So it's it's also the time if if you have, you know, if you've received inheritances or or things like that that you can use things like carry forward relief. I mean, you don't have to have used inheritance or have to receive an inheritance. You could have just built up some cash savings, but you can use things like carry forward relief as well.
Craig Rickman:So, yeah, that's that's the I guess, again, you you you have time to to do something about it, which is either, yeah, boost your savings or maybe think think or rethink when the point that you that you sort of plan to retire.
Kyle Caldwell:And carry forwards relief. This is when you can put money into your pension when you've not put the full amount in over the past three previous years. Is that correct?
Craig Rickman:Yeah. So it allows you to tap into unused pension allowances from from previous tax years. So there's an annual allowance on what you can pay into pensions, which is the lower of a 100% of what you earn or £60,000. So for example, if you earn £70,000 a year, the most you can put into pensions is is 60,000 under the annual allowance. But by using carry forwards, so if you do have unused allowances in previous tax years, and as long as you've been a member of a UK sorry, a member of a UK registered pension scheme during those years, then you might be able to to bring forward allowances from from those taxes and potentially pay in more than £60,000.
Craig Rickman:So, you know, it it supports those who have got, yeah, who who have got sort of either big cash savings or received an inheritance, have a decent income or a big income, and wanna make up for lost time.
Kyle Caldwell:So next up on our list of tips and tactics ahead of retirement is to consider whether you're gonna keep the money invested in retirement, take out an annuity, or do a bit of both. Craig, could you talk through each of these options?
Craig Rickman:I can indeed. Yeah. So essentially, there there are there are two retirement income products that you can use for your pension. The first, as you as you note, is, an annuity, which is a guaranteed income. If it's a lifetime annuity, that's it.
Craig Rickman:That means, yeah, for life. So you trade some or all of your pension savings for that facility. So you no longer have access to that pot of money, but instead, you get this guaranteed income. It's paid to you typically of every month. And there are there are various things that you can sort of choose and how that income is is paid to you.
Craig Rickman:So you can have it paid to your spouse or carry on to your spouse if you pass away. You can build all sorts of, you know, other guaranteed periods into them as well. So should something happen to you, then it will be paid for a certain number of years. So that there are various options that that you can take with it. But the things with annuities is they're they're they're rigid.
Craig Rickman:So once you bought one and the the cooling off period has has passed, you can't change your mind. So that's that's fixed for life. So though they they provide, you know, a lot of security, yeah, they're they're they're incredibly rigid. You need to be pretty certain before you buy one. So that's one option.
Craig Rickman:The other is is income drawdown where you keep your money invested and you draw income flexibly. That is the the popular option or has been since something called pension freedoms was introduced in that was in 2015. And so that's what most people tend to do. But it's but it's I think now is or or five years from retirement is the point where you you may start to think about which one you want to do. Like, you know, you can do a bit of both.
Craig Rickman:And I think that's that's the beauty of it is that it's trying to find the right way for your personal circumstances. Some people will do a bit of both. So they might use an annuity, to meet everyday costs, and then have, a drawdown pot, to use for for flexible spend. Some people might wanna just have the whole lot in drawdown. I mean, it it would depend on a number of things.
Craig Rickman:It would depend on how much other secured income you've got. Perhaps you've got defined benefit schemes, for example. And if you do, if you've got a generous defined benefit scheme, that that may sort of open the door for for, you know, using the rest of your savings or your defined contribution savings in a flexible way. But yeah. Yeah.
Craig Rickman:I mean, essentially, every every you get you get to choose, but now is a good time to think about it because or five years is a really important time to think about it because that may inform, like like, some of the decisions you make there on in particularly how you invest your savings in in the run up to retirement.
Kyle Caldwell:And that's the next point we'll come on to. I just wanted to briefly say, I think it's important to bear in mind that with going down the annuity route, once you buy an annuity, you can't reverse the decision.
Craig Rickman:Yeah.
Kyle Caldwell:And if you do put it off, you do tend to typically get a better rate in terms of annuities the older that you are.
Craig Rickman:Yeah. Yeah. I mean, it's based on risk for the the life insurance companies. The longer they expect you to live, the lower the annuity payment is going to be. So, yeah, if you if you take one out when you're older, the likelihood is you'll get paid more.
Craig Rickman:That will depend on annuity rates at the time. They they can change as we've seen recently. They were incredibly low in the in the previous decade. They have been low for for several years, but they've increased recently. They're a lot more attractive.
Craig Rickman:But for many people, they they they don't like the the rigidity of them. They they they they like the flexibility that draw down. I mean, the figures the figures support that. But it but again, yeah, you you you get to choose. So it's but it's but it's it's important to think about it before you reach retirement rather than sort of getting to that point where you're, you know, you're very, very close to packing up work and then sort of making decisions with not necessarily in a panic, but in you give yourself less time than perhaps you would have done otherwise.
Kyle Caldwell:As you've just touched on, it's really important to think about what you're gonna do, because this will shape the types of investments that you hold. Mhmm. And if you're in a workplace pension scheme, you may be in a so called lifestyling fund. What these funds do is they derisk as you approach retirement. And these funds were designed for people that were gonna go and buy an annuity.
Kyle Caldwell:Whereas if you're gonna keep your pension invested in retirement, you potentially got, you know, hopefully, a twenty, thirty year, maybe even more time period to go. So at that point, you I just don't see the sense in the pension being derisked when you've got such a long time horizon?
Craig Rickman:Yeah. Absolutely. Yeah. Again, that that just illustrates why it's so important to to to manage your your investments in the in in the years in the years as you approach retirement. Yeah.
Kyle Caldwell:However, the good news is there are certain tactics you can put in place to have a defensive buffer in your portfolio in the room up to retirement. Craig, could you talk through some of the options that are available for people in that scenario? So they're they're around five years away from retirement. They wanna take some risk off the table, but they don't wanna take all the risk off the table because they also wanna ensure that their pension pot is exposed to some growth assets in order for it to potentially and hopefully grow?
Craig Rickman:Yeah. Sure. I mean, there are there's there's no sort of fixed way to go about this. And, you know, for some people, they like to to manage things on a on a yearly basis and then consider whether they're gonna take a a bit of risk off the table. I mean, that's what some people recommend anyway, that as you age, that you that you take less risk.
Craig Rickman:You know, we also must take account of the fact that risk appetite is a very personal thing. And, you know, some people are are happy to take pretty sizable risks. Other people are more cautious. Some are in the middle. It's about finding out what works for you.
Craig Rickman:But I think as a for most people, as as a or most savers as a as a bare minimum, even if they're using drawdown, they're gonna want some secure assets that cover, you know, a a certain number of years income should, you know, something stock markets have a really, really tough time just before you retire to avoid, yeah, selling out of of the the equity portion of your portfolio, which exposes you to risks such as pound cost averaging and and sequencing of returns, which essentially mean that if you're drawing out or you're if you're selling shares in periods of poor market performance, that's gonna affect how they rebound and essentially, you know, how long your money might last in retirement. So most will wanna build some kind of some kind of buffer. You you you'd want a you need a plan b. So you go and it and sometimes I think it's just to it's it helps just to ask yourself that question if this happened. So if stock markets, excuse me, tanked 30% in in the in the run up to retirement, what would I do?
Craig Rickman:Would would it would it mean that I I still wanna retire on that date and I and I and I need some money to tie me over until things recover? Would I delay retirement? Is there are there other assets that I can tap into? I think it's just important to ask yourself that question, and then you can find the answer to it. And you might already have the answer to it in your portfolio, but if you don't, you've got five in your five years on your side to find it.
Kyle Caldwell:An option on the table is having some exposure to money market funds. So these funds are very low risk way to gain an income from a fund. So they invest in bonds with short term lifespans, and they typically yield. So this is the income generated from the funds around the Bank of England base rate. So at the moment, there's a there's a bit of a lag.
Kyle Caldwell:There's usually a couple of months lag. So you'd expect in a couple of months time, those money market fund yields, they will reduce to around 3.75. At the moment, some of the funds are are more closer to 4%, but that's an inflation beating income return at the moment. Of course, you may see further interest rate cuts this year. And from what I read and people I speak to, the consensus does seem to be that there'll be at least one interest rate cut this year, maybe two.
Kyle Caldwell:And when that happens, the amount of income that money market funds are producing will reduce as well. However, at the moment, I mean, you you could have you could treat it as, like, a separate part of your portfolio. You could put a certain amount into a money market funds. And then, say, for example, you're close to retirement, and the stock market suddenly and unexpectedly falls quite considerably, then you could dip into the money market funds rather than selling your investments. You can give your investments grace time and grace opportunities to then recover.
Craig Rickman:Yeah. Yeah. And I think that's where things like money market funds are are really, really valuable. I guess the the the big decision around that is how much how much do you hold in in cash? How much security do you need?
Craig Rickman:Because holding cash is is the the the the potential for growth isn't as high as what you get with shares. And so if you hold cash, you're holding it for long periods, then that can cause a drag on your retirement portfolio's performance. And again, that can impact how how long that potentially that that pot last. So that's that's the big question for people is how much how much cash do I hold? And that will typically be could be based on sort of personal circumstances, income, and access to to other forms of sort of low risk savings that you might hold outside of a pension and attitude to risk as well.
Craig Rickman:But again, thinking about it ahead of retirement can avoid a nasty shock when you get there.
Kyle Caldwell:And there are other options available. Of course, you don't have to pick the funds yourself. You could outsource decision making and pick, for example, a multi funds that will hold a mixture of shares, bonds, maybe a little bit of cash as well. And, I mean, the the key things to look out for with multi asset funds is to understand the level of risk as the ones that have a higher amount of exposure to shares, they're gonna be riskier than those that have less in shares. As ever, it's it's important to try and strike a balance between risk and rewards.
Kyle Caldwell:And for me, it's not a surprise to see a lot of people like income producing assets at retirement as this can help your portfolio have growth, and they can also help when you withdraw some of the money from the pension that you're taking some of the money that's been generated through dividends that have been paid?
Craig Rickman:Yeah. And I think that is the the sort of opens up something else, which is a a a sort of a quite a reasonably common strategy or a popular strategy that's that that some people use in in in retirement, which is bucket strategies, where you have sort of various buckets or pots for different time frames. So you can have one for for short term, I don't know, one to four years, for example, and that might be in things like cash or cash like savings, like money market funds, a medium term bucket where there may be some shares, but also some some fixed interest in there as well, and then a longer term bucket with equities. And so so, yeah, the longer the time frame, typically, the riskier the assets you have. And, again, as you sort of edge towards retirement, that can be a good time to get these these buckets in order.
Craig Rickman:So, again, so you know that if if if something if stock markets aren't aren't performing particularly well, that you've got this strategy in place. And it just it means that you can reach retirement with a with a bit more confidence as well.
Kyle Caldwell:And the last of your tactics ahead of retirement is to start thinking about whether you're gonna take advantage of the 25% tax free lump sum straight away or whether you're gonna take it in stages or indeed you could delay taking it. You don't have to take it straight away as soon as you access your pension.
Craig Rickman:No. Yeah. That's that's one of the, yeah, the big question. There's been a you know, I I won't get too too much into the all the speculation about tax free cash. I'm sure most people are been pretty sick of that.
Craig Rickman:But yeah. I mean, the the the you know, what's happened with it is is underscored just how much value people put on the tax free element of their pension. Like, I think, like we said earlier, keeping tax bills low in retirement is is really important. It means that, you get to spend more of the money that you that you've saved. So thinking about how to use it, like you say, you can you can take the lot in one go if you like, or you can you can take it out in in chunks.
Craig Rickman:You know, sort of which route you go down will, you know, typically be informed by whether you need the whether you need the cash for for a purpose. So for example, common things might be to clear debts, to go on nice holidays, to make home improvements. But if you've got a purpose for the money, yeah, then then taking all of your tax free cash or a large chunk of it can make a lot of sense. Other people prefer to to to withdraw their tax free cash in stages and use it as a as a form of income, as a form of tax free income in retirement. So, again, so it means that the income that they're drawing out of their pension can go a bit further.
Craig Rickman:But, yeah, that that would depend on, you know, your situation at the time. But I think that's, you know, even thinking about how to use your tax free cash, and if you're thinking about debts, that's, you know, that's a really useful exercise anyway because most people wanna reach retirement debt free because that, again, means that you can that the money that you draw from your pensions and your state pensions, that isn't being swallowed up by by mortgage payments. So, yes, it's a good time to the sort of five years out is a good time to think about that and particularly if you're thinking about how to use your tax free cash. But I guess the good news is you don't have to make any decisions at at that point, but you do it's yeah. It's it's it's worth getting getting ahead there so that when you do hit retirement, you're confident that you're aware of all the options regarding how you use your tax free cash, and then you can select the one which is most appropriate for you.
Kyle Caldwell:Well, Craig, you've covered a lot of ground there. I'm sure that's gonna be provide plenty of food for for for listeners. So thank you very much for coming on the pause again.
Craig Rickman:Thank you very much, Kyle.
Kyle Caldwell:And thank you for listening to this episode of On the Money. As mentioned at the start, you can get in touch by emailing otm@ii.co.uk. And in the meantime, you can find plenty of practical pointers regarding personal finance, pension, and investments on the Interactive Investor website, which is ii.co.uk, and I'll see you again next week.