Can You Work and Live Off Your Pension?

But it also means that pensions need to work harder to maintain a decent quality of life, possibly for another 30 years or more. With generous final salary schemes now mostly a thing of the past, anyone thinking of retiring may need to think more flexibly. This might involve retiring gradually, moving into a less demanding role, or making a living from your hobbies.

Pension legislation finally caught up with this need for flexibility in 2015 with the introduction of Pension Freedoms. Anyone over the age of 55 can draw benefits from their pension however they wish, whether this is in the form of a regular income, ad hoc lump sums, or even a full pot encashment.

Using your pension to supplement a reducing income can be a sensible way to transition into retirement. But there are a few potential pitfalls to be aware of, and there may be other options that better suit your circumstances.

Reasons to Combine Work and Pension Income
There are a number of reasons why you might want to draw on your pension while you are still working, for example:

• Reducing your working hours and making up the difference by drawing an income from your pension.
• Withdrawing a lump sum to clear your mortgage or other debts.
• Funding large purchases such as home improvements or milestone holidays.
• Supporting family members. Many people of retirement age are providing some level of support to adult children as well as ageing parents. Drawing on your pension can help to ease some of the financial pressure.
• Using the money to transition into a new lifestyle, for example, a new business venture or a move to the country.
• Providing a temporary income if you need to take time out of work for health or personal reasons.

The key is to work out what you would like to achieve, then establish the most efficient way of doing this. Pensions may or may not form part of the solution.

Tax on Your Pension
When you take benefits from your pension, 25% of the pot is available free of tax. You can take this all at once or phase it over a number of years.

The other 75% must be used to provide an income, although the term ‘income’ is applied loosely. This might take the form of a regular withdrawal, a series of lump sums, or even a full encashment. You can use this pot to buy an annuity if you want to secure a fixed regular income for the rest of your life. Any income drawn from this pot is taxable at your marginal rate.

If you are still working, it’s likely that you will have used up most (or all) of your personal tax-free allowance (£12,570). This means that any pension income you take in addition will be taxed at 20%, 40%, or even 45% (19% - 47% in Scotland) depending on your situation.

This needs to be carefully considered if you are thinking of taking your pension. Deferring your pension not only gives the fund more time to grow, but it is also likely that you will pay a lower rate of tax once you are fully retired. Over the longer term, this means more money in your pocket.

The Money Purchase Annual Allowance
A potential danger of taking retirement benefits while you are still working is the Money Purchase Annual Allowance (MPAA).

If you take a flexible income from your retirement pot, this means that you can only contribute £10,000 (gross) per year to pensions in the future, with no option to carry forward allowances from earlier years.

For many employees in a standard workplace pension, any future contributions they make will be well within this limit. But for higher earners or business owners, it can heavily impact pension planning and tax relief.

Remember, the limit applies for the rest of your life and your circumstances may change. Many people retiring in their 50s return to the workplace, sometimes in highly paid roles.  

The following benefits do not trigger the MPAA, and may offer an alternative if you want to keep future flexibility over pension contributions:

• Taking your 25% tax-free lump sum
• Using some, or all of your pot to buy an annuity
• Drawing benefits from a scheme pension
• Taking benefits from a plan which was already in capped drawdown before 2015, although only up to the maximum limit set by the Government Actuarial Department.

Tax Planning in Retirement
There are a number of options that can help keep your tax bill under control as you transition into retirement, for example:

• Withdrawing your 25% lump sum first to avoid paying more tax and triggering the MPAA.
• Drawing on other investments in a tax-efficient order, for example, cash first, followed by taxable investments, ISAs, and finally pensions.
• Joint planning with a spouse to make sure both sets of tax allowances and exemptions are used.
• Adapting your income to your needs and tax position, for example, reducing taxable withdrawals when your State Pension starts.
• Deciding not to take benefits from your pension at all. Pensions grow tax-efficiently and are not included in your estate for Inheritance Tax purposes. If you have other income and assets, you may want to preserve your pension for your beneficiaries.

Transitioning into retirement gradually is an entirely sensible goal. It not only has a financial benefit, but can also help with the mental shift into a new lifestyle. But it’s important to plan ahead and carefully consider the tax consequences.

Please do not hesitate to contact a member of the team if you would like to find out more about planning for retirement.