How much retirement income might £500,000 buy?

Thanks to the pension freedoms that came into effect in April 2015, you have a lot more choice about what you can do with your pension pot. You no longer have to buy an annuity and income drawdown is available to everyone. But all this choice means that making the right decision has become a great deal harder.

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More choice, but more thought needed

Retirees today have far greater flexibility when it comes to accessing the money in their pension pot. However, with this flexibility comes the possibility of making the wrong decisions. Under income drawdown, there’s a risk that drawing too much income each year could see you using up all of your pension fund within your lifetime, leaving you short of the income you need.

Some people may shun annuities because they want to pass on their pension pot on death. But if they live longer than expected, there may be nothing to pass on and they may even run out of money.

Figures show someone with £500,000 in pension savings who buys an annuity at age 66 could currently expect annual retirement income of nearly £31,500 a year¹. This is less than the £43,100 net annual income which the Pensions and Lifetime Savings Association says is required to fund a ‘comfortable’ retirement for the average single person.² You may also be entitled to the full state pension, which is currently £221.20 per week (just over £11,500 per year).

So, if you have a £500,000 pension pot, what could you consider doing with it? First of all, you need to think about more than just your pension savings. A financial adviser will look at your broader personal and financial circumstances to ensure your retirement income strategy meets your needs and that all the risks are fully considered.

Best to consider all your finances

It’s wise to consider all your assets and savings, not just your pension, when planning your retirement income. The sensible route is to speak to a financial  adviser  and take a complete approach to all your assets. Income drawdown might be the right approach for some people, whereas others could be better off spending other assets and leaving their pension alone. Buying an annuity with part of your pot is another potential solution to consider.

An annuity will provide you with a guaranteed income for life, no matter how long you live, so will offer certainty. However, they are inflexible – you can’t change your mind once you’ve bought an annuity, and you can’t vary your income to reflect any changes in your circumstances.

Under current rules, someone who has other investments available to them could find that the tax applying to their pension fund on death could be lower than the inheritance tax (IHT) on other assets in their estate. They may well be better off by accessing other funds for income in retirement and preserving their pension pot.

Pensions are currently one of the most tax-efficient ways to pass on your wealth. Under the current rules, if you pass away before the age of 75, benefits left in a money purchase pension can be paid as a lump sum, annuity or drawdown income to any beneficiary, with in most cases no tax to pay. After the age of 75 they will be taxed at the beneficiaries’ marginal income tax rate³.

However, measures announced in the 2024 Autumn Budget mean that from April 2027, the value of unused pension funds and death benefits will be brought into a person’s estate for IHT purposes.

This may have a significant impact on how pensions are viewed as part of succession planning, and how you may wish to structure the income you take in retirement to ensure it’s taken as tax efficiently as possible. Further information on the application of the rules will be made available by the government in due course.

Meanwhile, if your pension is your main income source for the rest of your life, income drawdown on its own might not be the best choice because the risk of exhausting your fund could be too high .

If we assume for the sake of income drawdown that the £500,000 pension fund grows at 5% a year after charges and that the income increases annually with inflation, then that fund could provide annual income of around £31,500 from age 66 until age 86. For those with more modest needs, the fund could provide a £25,000 annual income until age 95.

Income drawdown is flexible because you can adjust the amount and frequency of your withdrawals. As your pension remains invested, there’s also the potential for your savings to grow over the long term. However, as with all investments, there’s risk to be considered, too.

Next steps

Taking some financial advice can help you make an informed decision about how to access your money in retirement. By taking a holistic look at your finances, an adviser can find the best way of achieving your retirement aspirations.

Find out more from our dedicated customer support team based in Edinburgh by calling us on 0333 207 9003, or by sending an email to customer.services@brewin.co.uk. Opening hours: Monday – Friday 8 am to 6 pm, and Saturdays 8 am to 12 pm.

¹ Annuity assumptions: single life, monthly in advance, no guarantee period, non-smoker, standard (healthy) rates, 2% indexation, payable for life. Quotes obtained from Iress on 25 October 2024.
² http://www.retirementlivingstandards.org.uk/
³ Gov.uk: Tax on a private pension you inherit

The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Neither simulated nor actual past performance are reliable indicators of future performance. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.