Could You Unlock Your Pension Early?

September 19, 2012

Why retire early?

As we head toward retirement, we naturally start to think about the change of life that will befall us – some would say be forced upon us. Some hope to put the date of retirement off as long as possible, whilst for others it can’t come soon enough. There are many reasons for considering early retirement, and these include redundancy, ill-health, and the desire for a change of lifestyle.

Early retirement will allow you to have a longer and (hopefully) more rewarding retirement, or if in ill health enjoy a longer period without work and when you will be able to do the things you want to do. But early retirement means that the savings or investments you have built up will need to last longer. For many, early retirement is only viable if appropriate income can be generated, and for most early retirees this will involve unlocking pension benefits early.

What pension can you receive, and when?

Firstly, the state pension cannot be accessed until age 65. This amount you receive from your state pension when you begin to draw it will depend upon the number of qualifying years of national insurance contribution that you have. If you have built up 30 years of such contributions, then at age 65 you will be receive the full state pension (don’t forget that the state pension age is rising to 66 from October 2020). If you have not built up enough qualifying years, then it may be possible to purchase extra years to ensure you receive a full state pension when available to you

If you have a company or personal pension scheme, the ability to take benefits early will depend upon the specific rules attached to your scheme. However, by law the earliest you may take any benefits will be at 55 years of age.

Whatever the rules and whichever scheme you are in, you should remember that retiring early and taking pension benefits early will negatively impact the benefits available to you.

The effect on a defined contributions scheme

There are two effects that need to be considered.

First, you will have paid in for a lesser period of time, and so the fund built up will be smaller than it will be were you to delay your retirement.

Second, the smaller fund available will need to provide an income for longer. Not only will you have a smaller fund to purchase income, but because the income will be paid for a longer period of time the amount of income paid to you by an annuity will be smaller.

The effect on a defined benefits scheme

A defined benefits scheme will pay an income based upon final salary and years of service. If retiring early, your salary is likely to be lower than it would be in, say, ten years at normal retirement age, and the years of service used to calculate your pension income will be less. This can have a dramatic effect on your pension benefits.

For example, if you are a member of a 1/80 scheme, and have been employed by your company for 20 years when you retire at age 55, then you will receive 20/80 of your final salary. If you retire at age 65, your pension income will be 30/80 of your increased final salary. If your salary has doubled in the ten intervening years, then your pension income will be 1/3 of what it could be by retiring 10 years early in this scenario.

Are there other options?

For these financial reasons, often those that are considering early retirement decide against such action. However, for those who are considering retiring because of ill health then larger income payments may be available through impaired life or enhanced annuities. Many company schemes have clauses attached that allow for such circumstances.

For others, the lower incomes and lack of access to state pensions do not have to be the end of the early retirement dream.

Some company pension schemes allow the employee to retire gradually, replacing lost income with a portion of the pension built up. If your scheme does not allow this, then it may be worth exploring the possibility of transferring the pension fund into a personal pension scheme that allows this ‘phased retirement’. However, doing so may entail surrendering other valuable pension guarantees or benefits such as a spouse’s pension or death in service (if you are considering continuing to work part time, for example).

You may also consider an income drawdown facility, which allows you to take your pension fund in stepped payments whilst the balance of the fund remains invested for growth.

Be prepared for early retirement

If you are considering early retirement, then you need to prepare. You need to consider your outgoings and regular expenses, and calculate your income. Forecasts of pension benefits can be easily obtained from employers and personal pension scheme providers.

Many people will have several pensions from different providers if they have changed job several times during their working life. If you are in this position, then you will need to obtain illustrations of early retirement benefits from each one. Remember, also, that the benefits from all pension schemes don’t have to be taken at the same time.

Many people decide to semi-retire rather than fully retire early, taking a part time job and augmenting some of their pension income with income from earnings. You should also consider ensuring that you will receive the full state pension when it becomes available by purchasing extra years national insurance contributions, if you find yourself short.

Early retirement may be an option, but pension benefits will be severely eroded by retiring early. The earlier you make the move, the worse your pension income is likely to be, and the longer it will have to last.