What's the best way to generate income in retirement?

You have lots of choice over how you take an income in retirement. Which is best?

Elderly couple, aged 75-80, looking at photos on a tablet computer in a private retirement home

Pension freedoms mean you can now pick your own method for generating retirement income. You're free to buy an annuity, or to avoid them. You can keep your cash in your pension, or withdraw it and pick something else to invest in. Or you can pick a mixture of all the options. The question is what's the best way to do this?

The first step in this process is to understand your options. Annuities remain part of the picture, particularly for those who don't want to risk running out of money during retirement. For a variety of reasons, they don't produce the income they once did, but they are the only way to generate a guaranteed income for life with a defined contribution pension pot. Some people need certainty, and don't want to take any risks, so they will want to buy an annuity with the bulk of their savings. Others will want it as part of a broader mix.

Income drawdown is another popular option, where you leave your pension invested, and draw an income from the pot. This is riskier than an annuity income, because the value of investments can go down - leaving you with less money to live off than you were expecting. On the flip side, there's a chance that the value will increase, so those who are happier taking a risk may want to do this with at least some of their pension pot. Because this involves risk, it tends to be favoured by those who have a guaranteed income already - either through an annuity or from a final salary pension.

Taking the cash out and investing it is also a possibility - if you want to invest in something that cannot be held within a pension. Some people, for example, have chosen to withdraw large sums of cash in order to buy an investment property. If you do this, you need to consider the implications for taxes and any benefits you receive. You also need to appreciate that you are taking a risk.

Of course, unless you buy an annuity with the lot on the first day, you don't have to make one decision and stick to it. Some people opt for phased retirement, for example. Through this they may spend some of their pension pot on an annuity, and continue working part time to generate the rest of their income. The bulk of their pension remains invested. Later, when they stop work, they may choose to take a bit more of an annuity to cover the basic cost of living, and leave the rest invested for dipping into for one-off costs. Alternatively, they may convert the lot into an annuity.

The difficulty with the pension freedoms is that there's no single right answer to the question of the best approach to securing a retirement income. The upside is that if you plan carefully, then you can find the solution that suits you best.

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