A reader wants to know the best way to take their pension, as they approach the age they plan to retire

In our weekly series, readers can email in with any question about retirement and pension savings to be answered by our expert, Tom Selby, director of public policy at investment platform AJ Bell. There is nothing he does not know about pensions. If you have a question for him, email us at money@inews.co.uk.

Question: I’m 62 years old and planning to retire when I get my state pension at age 67, which should be worth just north of £12,000 a year (I’ve checked my entitlement using the government website). I’ve upped my private pension contributions in recent years and am expecting to have a fund worth around £450,000 by the time I access it. I’ve got plans for my tax-free cash, and I’m interested in using drawdown to take an income with the rest, but need a bit of help deciding how much to take out each year (I’m in rude health at the moment). Or should I just lump it and buy an annuity instead?

Answer: You’ve taken some really positive steps ahead of your retirement, knowing what you can expect to get in the state pension, increasing contributions to bolster your final pot value, and thinking about how you might take an income five years before you actually do it.

This is a solid financial planning foundation. For anyone wanting to check their state pension forecast, the government has a very useful tool.

In terms of the main rules, as you have a defined contribution (DC) pension – where contributions benefit from tax relief and your fund can grow tax-free too – you can access this from age 55 (rising to age 57 in 2028).

Up to a quarter can be taken tax-free (up to a maximum of £268,275 in 2025/26), with your remaining withdrawals taxed in the same way as income. Remember that while your state pension is paid to you without income tax being deducted, it does count towards your income for income tax purposes.

When you come to access the taxable part of your pension, there are three main options available. You can enter drawdown, taking a flexible income to suit your needs and keeping your fund invested; buy an annuity, a guaranteed income for life from an insurance company; or take ad-hoc lump sums from your fund, with a quarter of each lump sum tax-free and the rest taxed as income.

Given you’ve earmarked your tax-free cash already, I’m going to assume your decision is between a drawdown or an annuity.

Before getting into how much income you might be able to take via drawdown, it’s worth setting out how it differs from an annuity and what you should consider when making a decision.

The key benefits of drawdown are flexibility and the potential to keep growing your retirement pot as you take an income. You should only consider this route if you are comfortable taking investment risk and are willing to engage with your fund, reviewing your strategy at least annually.

It will be your responsibility to manage your withdrawals sustainably and, if your investments suffer significant drops (particularly in the early years of retirement), you may need to consider reducing your withdrawals. Equally, if your investments perform better than expected, you might be able to take a bit more income from your pot.

An annuity, on the other hand, is inflexible but offers the certainty of a guaranteed income for life. If you go for this option, you won’t need to manage your fund, as the insurer takes on all the risk.

There are various different flavours of annuity – for example, a flat rate annuity versus an annuity that rises with inflation, or a single life annuity versus an annuity that pays an income to your spouse when you die. The rate you receive from your insurance company will depend on which flavour you choose and your personal circumstances, including your health and lifestyle.

Shopping around for financial services products is always a good idea, but it is particularly crucial when it comes to annuities, as once you’ve bought one, there is no going back.

It is also perfectly possible to combine the security of an annuity with the flexibility of drawdown to create a retirement plan that fits your needs.

Turning now to the income you might receive, assuming a fund value of £337,500 (after taking your tax-free cash), this could deliver a flat annual income (i.e. one that doesn’t rise in line with inflation) of around £26,000 for 20 years (i.e. your fund would run out at around age 87) or £23,000 for 25 years (i.e. your fund would run out at around age 92). This assumes 5 per cent annual investment growth after charges.

If you bought an annuity paying a similar income today with that fund, you could receive a guaranteed (but inflexible) income of around £27,000 (Source: Moneyhelper annuity calculator). This annuity rate is sensitive to changes in interest rates, so if rates change between now and retirement, you may get more or less for your money.