Get ready to retire

There are a lot of things to think about as you get closer to your retirement. But the early you start to prepare, the better.

Make the most of the Basic State Pension

The Basic State Pension is money you get from the Government when you reach a certain age. On current rates (for the 2012/13 tax year) it provides a maximum weekly income of £107.45 a week. You'll only qualify for the maximum amount if you have built up enough qualifying years and paid enough National Insurance (NI) contributions before State Pension age.

To find out how much of the Basic State Pension you’re entitled to, get a State Pension forecast. If you’re more than four months away from retirement you can get a forecast online from GOV.UK.

You might find you don’t qualify for the full Basic State Pension if you don’t have enough qualifying years and there are gaps in your NI record. For each qualifying year that you have earned, you will get some Basic State Pension. But don’t panic because you can make up the shortfall by buying missing years with voluntary NI contributions.

When to start
You'll also need to think about when to take your Basic State Pension. You won't be entitled to start receiving any income until you reach the State Pension age. You can find out when this will be at the GOV.UK website. However, by delaying when you take the State Pension, you could receive a significantly higher income.

If deferring your State Pension makes sense, you have two choices: receive a higher weekly state pension at a later date or take an extra lump sum payment now. If you go for the lump sum option, you'll receive the State Pension at the normal rate when you eventually start taking it. 

Even if you have already started claiming, you can choose to stop receiving benefits for a time to build up an extra income or lump sum.

To receive extra weekly State Pension, you must defer for at least five weeks. However, if you want to receive a lump sum payment, you must put it off for a minimum of a year.

Other benefits
On top of the Basic State Pension you may qualify for a host of other benefits when you retire, depending on how much income you have. Extra cash for pensioners is available to cover the cost of heating, travel, health, TV licensing, as well as Pension Credit which can be a welcome boost to your State Pension if you're on a low income in retirement.

You can find out more about these at the GOV.UK website.

Top up your own pension

As you approach your retirement, you'll need to review your own personal pension provision, on top of the amount you'll get from the Government when you take your Basic State Pension.

If you find your pension pot isn't quite as large as you had hoped and you have some spare cash, take this opportunity to top it up. You can currently contribute up to £50,000 a year tax free into your pension scheme. If you don't have any earnings, you're allowed to invest £2,880 gross into a pension each tax year, which with tax relief becomes £3,600.

Tax relief
You'll qualify for tax relief on any contributions you pay into your pension. This means you'll get the tax back which has already been deducted from your earnings. If you're a basic tax payer (or a non tax payer) you'll enjoy tax relief at a rate of 20%, while higher rate taxpayers will qualify for 40% relief.

So if you're a basic rate tax payer and you pay £100 into your pension, a total of £125 will be invested in your plan once tax relief has been added. In other words, you get £25 for free

Move your pension into low risk investments

The chances are your pension has been invested in shares. This makes sense as it gives your pension savings the best prospects for growing in value over the long term. But the stock market can be volatile, so it's important you think about moving your scheme into less risky assets as you get closer to your retirement date.

Think about using what's known as 'lifestyling' to protect the value of your pension fund. This is a process where your pension money is automatically moved out of shares and into lower risk investments such as fixed interest bonds and/or cash. 

Typically, 10% of your pension will be moved out of your pension and into cash/bonds every year in the final decade before you retire. This means as you reach you retirement date, none of your pension is invested in shares and all of it is held in cash/bonds. This process protects your pension fund value from a sudden stock market crash just as you're on the verge of retiring.

Do it yourself
You don't have to use lifestyling to protect the value of your pension pot. If you prefer, you can simply switch how your pension is invested yourself. You may decide you want to go for the maximum capital growth you can by leaving your pension pot in shares until you take an income from it. But bear in mind, if the stock market falls dramatically during this time, your pension fund value will suffer.

Think about when you will take benefits from your pension

If you choose to retire early, then expect to receive a lower income from your pension than you would get if you had waited until normal retirement age. This is because your pension pot will be more thinly spread as it is expected to pay out for extra years reducing the annual income you'll receive.

Once you have taken an income from your pension it will no longer be invested, so there's no opportunity for further capital growth. Bear this in mind when you decide how early or late to retire.

In principle, if you put off taking benefits from your pension for a time, it should provide you with a higher level of income when you eventually start drawing it. What's more, if you continue to pay contributions into your pension fund during these extra working years, you could significantly boost the value of your scheme.

If your pension pot has fallen in value recently as a consequence of the current economic crisis, there's a strong case for leaving it invested where it is to allow a few extra years in which the value can hopefully recover. Of course, there are no guarantees, but if share price growth is better in the coming years, it could work wonders on the final size of your pension pot.

Think about how you will take benefits from your pension

When you get closer to your retirement date, there are several different ways you can take benefits from your pension. You'll need to decide which ones are most appropriate for you. Here are the choices.

Taking a lump sum
You'll have the option to take up to 25% of your pension pot as a tax-free lump sum. Remember benefits taken from your pension fund as an income, instead of a lump sum, are usually taxable. But by taking the tax-free cash out of your pension pot, you'll reduce the amount which remains to provide a regular income.

That said, your pension normally dies with you, so by taking the full tax-free cash you can guarantee that at least a quarter of it is in your hands, and won't be lost to your pension company should the worst happen to you early in your retirement.  

Whether it's actually better value to take the tax-free cash or not actually depends on how long you survive.

You might also want to think about taking tax-free cash where a higher pension income would push you up into a higher tax bracket. Remember, your pension pot is taxed in the same way as your pre-retirement salary. But if taking tax-free cash and a reduced income means you'll be in a lower tax bracket, then you would be better off from a tax perspective.

Should you buy an annuity?
After you've decided whether to tax-free cash or not you'll then need to decide what to do with the rest of your pension pot. Most people choose to buy an annuity which converts the pot into a regular guaranteed income.

Annuities can be adapted to provide an income which is fixed, increases in line with inflation or increases by a fixed percentage each year. If you choose an annuity which rises in value over time, then expect the initial amount of income to be lower than that provided by a fixed annuity which pays the same amount year in, year out.

You can also add a host of other features including:

• Spouses' benefits – you can arrange for your annuity income to be paid to your spouse/partner after your death.
• A guarantee period – without a guarantee period, your annuity will only last as long as you do. If you only live for one year after buying your annuity, the rest of your pension fund – which hasn't yet been paid out to you – will be completely lost to your heirs and retained by your annuity provider. By buying an annuity with a guarantee period you can ensure your income is paid out for a least, say, 10 years, and more if your survive longer. So if, for example, you have an annuity which is guaranteed to last for 10 years but you die after three, your income will continue to be paid to your spouse/dependant for the remaining seven years.
• An enhanced or impaired life annuity – these are special types of annuity which allow you to receive a higher income if you have a lower than average life expectancy. If, for example, you're a smoker or you suffer from high bold pressure you could be eligible for a better annuity. Or if you have a serious medical condition you may qualify for an even more generous income.

Read the next section of this guide for more information on annuities.

You don't have to buy an annuity
If you prefer you can draw an income from your pension fund while it remains invested on the stock market (or in other assets). This is known as unsecured pension or income drawdown. The main advantage is that there is the potential for your pension to carry on growing value giving you a higher income in retirement. But, on the downside, your pension could fall in value if the assets it's still invested in don't perform well.

Get the right annuity

Most people end up buying an annuity when they retire. An annuity converts your pension pot into a guaranteed income for the rest of your life. It's really important that you buy the right annuity for you because once you make your decision it cannot be reversed. This decision will live with you for the rest of your life. 

What you need to decide
You'll need to make several key decisions about how you want your annuity to be set up. For example, you can choose a single life annuity which will provide an income for you alone. Or you can go for a joint life annuity instead which pays an income to you and then your spouse, partner or financial dependant after your death. They could take an income of half, two-thirds or equivalent to the amount you were getting.

You'll also need to decide whether you want a level or increasing annuity. A level annuity means your income will always be fixed at the same amount each year. So your income won't keep pace with inflation and your purchasing power will gradually be eroded over time.

Alternatively, you could choose an increasing annuity, which will either rise in line with inflation or by a fixed percentage each year. This way, the value of your income will be protected from the effects of rising prices. But the level of income you receive will be lower initially than it would be from a level annuity.

The importance of shopping around
When the time comes to buy your annuity make sure you shop around for the best one. This is known as using the open market option (OMO). Annuity rates vary from one insurer to another, so it's really important you pick the most competitive one. The difference between the best and worse can be as much as 20%, so make sure you don't miss out.

As you approach retirement, your pension company will send you a retirement pack which outlines the amount of income they are prepared to pay you from your pension pot. Then all you need to do is compare the rate you've been given with the rest of the market. If you're not confident doing this yourself, a qualified financial adviser can help you, but there's normally a fee of around 1% of your pension fund for this advice.

On the other hand, if you're happy to go for it yourself there are a number of websites which can compare rates for you such as the annuity supermarket from www.annuity-bureau.co.uk. Or you can take a look at the latest best buys from pension provider and adviser Hargreaves Lansdown.

Once you've found the best deal make sure you act quickly because annuity rates can be changed at any time.

Don't forget, you may be lucky enough to have your pension with a company that also happens to be an annuity market leader. In which case, there's nothing to stop you staying where you are if the first rate you're offered is competitive.