Red letter day: When in the calendar year is best to retire?
Many might feel ‘as soon as possible’ is the only answer to when is best to put RETIRE in big red letters on your calendar.
But if you have the luxury of choosing the time of year as well as the age you want to give up work, there are certain financial considerations to bear in mind.
The turning of each tax year is an important marker, and this year many aspiring and current retirees are looking forward to a welcome 10 per cent bump in the state pension in April too.
Pension experts offer tips on the best time of year to make the move into retirement.
1. Income tax
‘It’s probably best to retire at the start of the tax year for most people,’ says Sean McCann, chartered financial planner at NFU Mutual. ‘On 6 April you start with a clean slate.’
He explains that by continuing to take a salary and then starting to tap a pension during the course of the same tax year, you can end up in a higher income tax bracket unnecessarily.
McCann points out that if you are a higher rate taxpayer while still working, it will be beneficial to engineer your income to become a basic rate payer in the tax year when you retire.
Tom Selby, head of retirement policy at AJ Bell, says: ‘The most common time for savers with defined contribution pensions to flexibly access their fund is in April, May and June, coinciding with the start of a new tax year.
‘This makes perfect sense as having a fresh set of tax allowances allows you to plan your retirement income strategy as tax efficiently as possible.’
2. Tax relief
Retiring at the start of the new tax year also allows you to make the most of tax relief on your pension contributions right up to the end of the previous year, suggests McCann.
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‘Before you retire, it makes sense to maximise your pension contributions up to 6 April,’ he tells us.
And again, he says doing this works most to the advantage of higher rate taxpayers who can benefit from higher relief on their contributions right up to this point, then become basic rate taxpayers in the following tax year.
We explain the rules, benefits and practicalities of paying extra contributions into your pension here.
3. Emergency tax
When you retire and start making withdrawals from a defined contribution pension pot, at any time but particularly if you do it at the start of a new tax year, you need to be aware of this trap.
When you make your initial withdrawal, HMRC assumes it will be the first of many over the rest of that tax year, which could push you into a higher tax band than normal.
It therefore applies an emergency tax rate on the basis that this could be ‘month one’ of a series of withdrawals.
The tax deducted might be particularly onerous if you make a large pension withdrawal in April, at the start of a new tax year, and don’t plan any further ones.
However, you can claim the tax back, or if you don’t do this proactively you should get a refund via your tax return after the end of the current tax year.
Pension experts suggest making smaller withdrawals and spreading them out, so you are taxed correctly at the start of retirement rather than having to claw overpayments back later.
What’s the difference between defined contribution and defined benefit pensions?
Defined contribution pensions take contributions from both employer and employee and invest them to provide a pot of money at retirement.
Unless you work in the public sector, they have now mostly replaced more generous gold-plated defined benefit – or final salary – pensions, which provide a guaranteed income after retirement until you die.
Defined contribution pensions are stingier and savers bear the investment risk, rather than employers.
4. Tax free cash
Defined benefit pension schemes have differing rules regarding tax free cash, so check what is currently on offer – and bear in mind that these deals are getting poorer at the moment due to interest rate rises.
Some schemes can be stingy with lump sum offers when members begin retirement.
You can take anything up to 25 per cent tax-free. But the bigger the lump sum you withdraw, the more future pension you sacrifice, and some schemes force you to forfeit more than others.
How much you get is determined by your ‘commutation’ rate or factor. For example, for every one pound of pension you give up, you will get X amount in a lump sum – so the higher X is the better.
Patrick Bloomfield, senior actuary at Hymans Robertson, warns that these lump sum offers are getting less advantageous at the moment.
‘If you’re looking at the options your scheme offers, such as tax free cash, it’s probably better to do it as soon as possible,’ he says.
‘A side-effect of interest rates going up is that the terms for these sorts of options are generally being reduced, so asking for a guaranteed quote before any new terms come in may be worth doing.
‘This also varies from scheme to scheme, so you can ask when the last review was and when the next review is planned for (they are usually every three years).’
5. Annual inflation increase
If you have a defined benefit pension, you should look to start taking it just after your scheme has increased your pension for that year, suggests Bloomfield.
Again, he notes that this date will vary from scheme to scheme, depending on their rules, so you will need to check.
‘You don’t want to miss out on an annual inflation increase between the time you left the scheme and when you retire, as it could be worth a lot at the moment.’
6. Normal retirement age
If you have a defined benefit pension, your ‘normal retirement age’ will usually be when you reach your 65th birthday or your state pension age, says Andrew Tully, technical director at Canada Life.
‘It could be different, depending on your defined benefit pension scheme’s rules.
‘Depending on your scheme, you might be able to take your pension earlier, but this may reduce the amount you get. It is possible to take your pension without retiring.’
Bloomfield says: ‘Find out how much your pension would be reduced by for each year you take it early or increased by for each year you wait.
‘You might be better off to live off your savings and wait a year or two before starting your pension.’
Weather forecast: Many people like to retire in the spring and summer
If you are made redundant you should consider retiring whatever time of the year it is, especially if you are over 55 and therefore allowed to start accessing your private pensions, according to Tully.
He explains how to maximise the benefits of a redundancy payout and the tax rules, as follows: ‘Redundancy payment over £30,000, avoid 40 per cent tax, invest the balance in your pension and then retire.
‘The closer to the tax year end, the more tax control you may have, if you use redundancy as a reason to retire, or partially retire.
‘Use tax-free cash as income to avoid 40 per cent tax, wait until following tax year and have full allowances for tax efficient retirement.’
But Tully cautions: ‘Your pension may have valuable guaranteed annuity rates attached and there may be a narrow window to claim these very worthwhile benefits – so you’ll need to check your pension paperwork to see exactly when that claim window is.’
Bloomfield adds regarding defined benefit pensions: ‘Redundancy may also have advantages, relating to pension planning.
‘In some cases, you could fund a pension with redundancy payment and immediately retire with no penalty as your scheme offers special terms. Check the scheme rules.’
Patrick Bloomfield: Find out how much your pension would be reduced by for each year you take it early or increased by for each year you wait
8. State pension
Many people choose to retire on their 66th birthday when their state pension starts, though you do not have to stop work when you begin drawing it.
You can defer the state pension if you want, and this might be a good idea if you are still taking a salary and it would push you into a higher tax bracket, or put the state pension on hold but only once.
Tully says: ‘The timing for claiming the state pension is pre-determined by your date of birth.
‘Ask the DWP for your state pension forecast (you can do this online at any point) to not only check your claim date but also whether you will have the full 35 years national insurance contributions against your record to receive the full state pension.
‘You can delay claiming your state pension, and for each year you do so will add 5.8 per cent to the value of future payments.’
Selby points out that the annual ‘triple-lock’ increase is applied every April, and this year will come in at a whopping 10.1 per cent making the state pension worth £10,600 a year if you qualify for the full rate.
‘In light of this, waiting until that increase is in place could make sense as for many people the state pension is the foundation around which their retirement income strategy is built,’ he says.
‘As your state pension counts for income tax purposes, this blockbuster increase could also impact how you manage your withdrawals if you are focused on minimising your income tax liability.’
Some people try to live only or partially on the ‘natural’ or dividend income generated by their investments in retirement
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It’s also sometimes advisable to switch to doing so if you can afford it when financial markets are troubled, to avoid crystallising losses.
Dividends might be a factor to consider when you are timing withdrawals at the outset of retirement, according to Selby.
‘Anyone planning to use dividends within their pension to fund their lifestyle might want to wait for those dividends to be paid in order to leave their underlying investments intact.’ says Selby.
‘Equally, anyone receiving dividends from sources outside their pension may also choose to time withdrawals to coincide with these payments, as they could have an impact on their tax liability.’
10. Work benefits
‘You may be accruing holiday pay or there may be other staff benefits like bonus pay to think about when choosing when to retire,’ says Tully.
11. Planning as a couple
Couples who make decisions about pension saving together are more likely to have a richer retirement, according to recent research.
We looked at how couples who save together can max out their pensions here.
‘Consider when your partner plans to retire – are you taking the step together,’ says Tully.
‘You may have big plans for holidays or family celebrations which determine at what point during the year you choose to retire,’ he adds.
12. Good weather
‘Retiring in the springtime is better for most people than in the middle of winter, though everyone’s situation is different, says Sean McCann of NFU Mutual.
Tully agrees on timing your move in the sunnier months, saying: ‘Spring and summer in the UK is always going to be a nicer time to retire than in the depths of winter.’