Pension: Defined contribution options in retirement explained | Personal Finance

The first thing you need to know is what type of pension savings you have, apart from your state pension. There are two types: defined benefit (or final salary in layman’s terms) or defined contribution.

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These are the gold standard of retirement funds – workplace pensions which give you a guaranteed income, based on your salary and length of service.

They are becoming increasingly rare these days, as employers find them too expensive to run.

The only real downside is that the new pension freedoms do not apply to these schemes.

You can’t dip into your pension pot. You typically get a tax-free lump sum and the rest goes to provide you with a guaranteed income for the rest of your life.

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These are workplace and private pensions where the total amount of money in your pension pot is based on the contributions made by you, and often by your employer, and how much

investment income the pension fund earns over the years of saving.

With these schemes, under the changes introduced in 2015, you get to choose how much money you want to take out and when you take it.

The new pension freedoms allow you to access funds from the age of 55. But this is just a starting point, it’s not a deadline.

If you don’t need the cash, then you don’t need to access your pot. Your best option could be to leave it all invested, until you actually need the money.

If you are heading towards the right time to access your pension, you have five options to choose from, outlined on the right.

With most defined contribution pensions you can take 25 per cent tax-free. The rest of it is taxable, and how much you pay will depend on when and how you take it.

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Use your pension to buy an annuity – an insurance policy that will give you a guaranteed income for life.

On a £60,000 pension pot, retiring at age 66, that could equal a £15,000 tax-free lump sum, with an income of around £2,300 a year for life from the remaining £45,000.

That is for a single-life, non-escalating annuity, which means the income would stay at the same level all your life and would stop when you die.

But there are other sorts of annuities to suit different needs. You can buy an annuity that will increase each year to keep up with inflation, or one that continues to pay out

to a dependent after you die.

And there are enhanced annuities that pay out higher pensions to people expected to die sooner – for example, smokers and those with certain medical conditions.


Your pension pot remains invested to give you a regular income that is adjustable to suit changing needs.

This is usually called flexi-access drawdown. An £80,000 pension pot, accessed at age 66 (assuming growth at 3 percent per year) could provide a £20,000 tax-free lump

sum and a monthly income of around £341, until you reach 85.

Or you can take your remaining balance in differing amounts as you wish. But you need to keep an eye on your balance if you want this cash to last for your retirement.

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As it is still invested, it is still at risk from fluctuations in the money markets. Your balance could go down as well as up.

You will also have to pay fees out of your fund to the company managing your investments.


Here you withdraw smaller sums of cash from your pot until it runs out. You decide when and how much you take.

Instead of a tax-free payout on retirement, each time you take out money, 25 percent is tax free and the rest is taxable at your nominal amount.

This option isn’t available through all pension providers. If yours doesn’t offer this, you can think about transferring your pot to a provider who does.

This can mean you can spread cash withdrawals over more than one tax year, and you might pay less tax.



Cash in your whole pot in one go. The first 25 percent is tax free, the remaining 75 percent is taxable.

Timing is vital if you choose this option. For example, accessing a pot while still working could nudge you into a higher tax band, and mean you pay 40 per cent on the taxable cash.

But if you wait until the tax year after giving up work, or when you are earning a lower amount, you could keep the tax you pay to a minimum.


You can use some of your pension pot to buy an annuity and create a guaranteed income for life and then leave the rest of it invested to access as you wish. Or, if you have more than one pension, you can use different options for each pot.

On a £60,000 pot, at age 66, you could, say: Take a £15,000 tax-free lump sum, turn £20,000 into an income for life – around £800 per year (on a single-life annuity that doesn’t change for the rest of your life), and leave £25,000 invested.

You can take this last sum either as an adjustable income or access it as you need it, say a withdrawal of £5,000 a year for five years.

But remember, any cash left invested is at risk, as the value of investments can go down as well as up. And again, there will be management fees to pay that will come out of your fund.