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Early retirement - effect on your pension

If you retire early, or stop work due to redundancy, ill-health or other reasons, your State Pension and other pensions you're entitled to may be affected. You need to know all your pension options to make sure you'll have enough to live on in retirement.

Retirement age and claiming your pension

Although you can retire at any age, you can only claim your State Pension when you reach State Pension age.

For workplace or personal pensions, you need to check with each scheme provider the earliest age you can claim pension benefits. If you're retiring because of ill-health you may be able to take your benefits before the set age.

If you have serious ill-health and your life expectancy is less than a year you can retire at any age. You can take up to 100 per cent of your pension fund as a tax-free lump sum. If you're married or have a civil partner, up to 50 per cent of the pension fund may be retained by the scheme. This will be used to provide for a survivor's pension.

Changes to State Pension age

The State Pension age is increasing. To find out more see ‘Calculating your State Pension age’.

Effect of early retirement on your State Pension

If you retire before State Pension age you won't receive a State Pension immediately.  You may receive less when you reach State Pension age than if you'd continued working. This is because you get a State Pension by building up enough 'qualifying years'. A qualifying year is a tax year in which you have enough earnings on which you have paid National Insurance contributions (NICs). It also includes a year in which you are treated as having paid or have been credited with paying NICs.

Boosting your National Insurance contributions (NICs)

There are ways to improve your NICs record:

When can you take your personal or workplace pension?

You'll need to check your options for early retirement with your workplace, personal or stakeholder pension scheme – the rules vary on whether and when you can retire. For example, many schemes allow early retirement on grounds of ill-health when you become incapable of doing your job because of physical or mental impairment.

Effect of early retirement on 'money purchase' arrangements

If you're a member of a personal pension, stakeholder pension or workplace money purchase scheme, the main points to remember are:

  • you've had fewer years to pay in, so your pension fund will be smaller
  • your pension fund will need to provide you with an income over a longer period, so the pension you get will be smaller

Example (money purchase arrangement)

If you started paying into your pension at age 35 with a life expectancy of 85 then:

  • if you retire at 55 the fund built up over 20 years must last 30 years
  • if you retire at 65 the fund built up over 30 years must last 20 years

If you're retiring early due to an illness that's likely to effect your life expectancy, then some providers may boost your pension.

Effect of early retirement on 'final salary' schemes

With these schemes the pension you get when you retire is usually based on a fraction of your salary. This fraction is then multiplied by the number of years you were a member of the scheme. So if you're considering early retirement you'll probably receive a smaller pension.

If you started paying into your pension at 35 and the pension is based on 1/80 of your final salary, then:

  • retiring at 55 would give 20/80 of final salary
  • retiring at 65 would give 30/80 of final salary

Many schemes also reduce the annual amount of pension they pay if you take payments before the scheme’s normal retirement age. This is to take account of the fact that your pension is being paid for a longer period.

Example (final salary scheme)

Michael is a member of a pension scheme that has a retirement age of 60. He retires at age 58 having built up a pension which is 35/80ths of his final salary. The pension scheme reduces the annual rate of pension by five per cent for each year if a pension is taken early. This means that Michael's pension will be reduced by 10 per cent because it is paid two years early.

Points to consider about your workplace pension

When looking at workplace pensions, remember that:

  • your workplace scheme may not allow you to take your pension before the normal retirement age of the scheme
  • if you retire early through ill-health there may be special terms in the scheme rules that allow for the pension to be enhanced
  • if you're made redundant with a pension, you could delay drawing it and let it build up – compare any special early retirement deal with all the alternatives
  • if you are going to work again, check the rules about transferring your old pension to a new employer's pension scheme - contact your pension scheme administrator
  • if you've had several jobs, you'll need details of all your pension rights

These are complicated points and you may benefit from getting independent advice.

Pension shortfalls - options and getting advice

If your pension won't be enough to cover you in retirement, some options you could think about are:

  • buying added years in a final salary scheme (where the scheme allows)
  • increasing your contributions to a workplace or personal plan - you can save as much as you like into different pension schemes (though you only get tax relief up to certain limits – read 'Pension rules from April 2006' to find out more)
  • using tax efficient investments like Individual Savings Accounts (ISAs) to support your pension
  • tracing pension rights from previous jobs

In this situation it's important to get early advice from an authorised financial adviser.

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