Five things to do before you retire

If you're approaching retirement in the next few months or years, here are five things you can do now to make your money go further in the future.

1. Boost your state pension entitlement.

First, figure out whether you will be entitled to the full basic state pension. To qualify you'll need to have enough 'qualifying years' which is a year when you have made sufficient National Insurance contributions or received credits instead (for example, because you've been receiving benefits such as Jobseeker's Allowance or Child Benefit). From the 6 April 2010 the rules were changed so that men and women now only need 30 qualifying years to qualify for the full state pension. This was reduced from 44 years for men and 39 years for women.

If you do not think you will have enough 'qualifying years' when you come to retire, you can buy extra years by paying voluntary class 3 national insurance contributions. This will increase the amount of basic state pension you'll receive.

If you reached State Pension age between 6 April 2008 or you will do by 5 April 2015, you may be able to pay voluntary Class 3 contributions for up to an extra six years - going back to 1975-76 - to make up any gaps in your National Insurance contributions record.

You can do this on top of making voluntary contributions for the last six tax years (or for any of the tax years for which there are extended time limits in which to pay). You pay at the current weekly rate - so if you pay by 5 April 2011 the rate is £12.05, or £626 a year.

Some people could earn additional income which easily exceeds the £626 they have paid to make up a missing year. But you should speak to a professional adviser or the Department for Work and Pensions to find out whether it's worth your while. For example, it won't benefit you if you aren't able to buy a sufficient number of qualifying years to meet the minimum needed to be eligible for any state pension at all.

2. Consider deferring your State Pension

Did you know that you don't have to claim your State Pension immediately? You can defer it, and get a top-up as a reward from the Government. This top-up is equivalent to about 10.4% extra for every full year you put off claiming.

When you do decide to start claiming your pension, you'll either get the extra cash on top of your normal weekly State Pension or - if you defer for at least 12 months - you'll get it as a one-off taxable lump sum. And the good news is, no matter how big it is, this lump sum will not push you into a higher income tax bracket.

Deferral may prove particularly cost-effective if you plan to carry on working past your State Pension Age, or once you stop working and officially retire, you'll fall into a lower income tax bracket.

Of course, State Pension Age is rising. You can work out when you'll reach State Pension Age using this calculator on The Pension Service website.

To find out how much you could get by defering your state pension, call ?the Pension Forecasting Team on 0845 3000 168 or read more about deferral here.

3. Increase your contributions

If you can, it's a good idea to increase your pension contributions shortly before retirement. This is particularly true if your income is set to drop significantly. Not only will it help to ease you into coping on a lower income, but you'll soon be able to take back 25% of the money you contributed, tax-free.

This is because, when you retire, you can take 25% of your total pension pot (from all sources) as a tax-free lump sum, as long as 25% does not exceed the £450,000 limit for the 2010-2011 tax year.

You'll also get tax relief on the contribution at your highest rate of tax as long as you earn enough in that tax bracket to cover the contribution. If you're a basic rate taxpayer, you'll qualify for 20% tax relief which means if you pay £800 out of your own pocket, £1,000 will be paid into your pension once tax relief has been added on. Menawhile, higher rate taxpayers will qualify for an additional 20% tax relief which can be reclaimed via their tax return.

What's more, if you're currently a higher rate tax payer now, but will become a basic rate taxpayer when you retire, it is tax-efficient to increase your pension contributions now. After all, you will get 40% tax relief on your contributions but only pay 20% tax when you come to withdraw it.

Use this helpful calculator to figure out how big your income will be in retirement, in comparison to your current income. And this calculator will tell what you will pay in taxes.

Finally, I suggest that your extra contributions are only invested in low-risk funds, such as cash and fixed-interest bonds. Due to the short-term volatility of the stock market, I think this is the best investment strategy to take if you're only a few years off retirement.

4. Reduce your tax exposure

Everyone is entitled to a personal allowance which is the amount of income you can receive before tax has to be paid. As you get older, the Government will increase your tax-free personal allowance in the following way:

What's the 'income limit'? This is the point at which your personal allowance starts to reduce. It decreases by £1 for every £2 above the income limit. So if your income is £500 over the income limit, your personal allowance will be reduced by £250. However, it will never be less than the basic Personal Allowance or Married Couple's Allowance. (For details of these allowances, visit HM Revenue & Customs.)

If your income is over £100,000, your personal allowance will be reduced in the same way, but it can drop right down to zero if your earnings are high enough.

Why am I banging on about all this? Because it allows you to plan more effectively. For example, are you planning to retire mid-way through a tax year? If so, you may want to consider deferring your pension or your State Pension until a new tax year, to retain more of your personal allowance. Alternatively, you may want to prioritise contributing to your partner's pension instead of your own, to ensure you both make the most of your individual allowances.

5. Shop around for an annuity

If you're planning to take out an annuity, don't assume that the company with which you've built up your pension fund is going to offer you the best annuity rate. Shop around in advance, using the FSA's Money Made Clear website to compare the different rates on offer.

Remember, you won't be able to change your annuity provider after you've made your decision, so be careful and take your time. For more information about annuities, read How to buy the right annuity by Jane Baker.

Here's wishing you a long and happy retirement! 

This is a lovemoney.com classic article which has been updated to reflect the 2010/2011 pension and tax rules.

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