Retirement Income Options
The ‘Freedom & Choice in Pensions’ legislation that came into force in April 2015 has dramatically changed and improved the options available to draw an income from your accumulated pension funds when you retire.
You now have total control of your pension and no longer have to purchase a totally inflexible and (more often than not) poor value annuity. From the age of 55 you are free to take as much money as you want from your pension fund and spend it as you wish. Considering the most suitable retirement income options is now about much more than merely securing the most competitive annuity rate.
You now have an infinite number of choices on how you use and enjoy your retirement savings, which is excellent news!
This choice and flexibility means it is now more important than ever that you do not ‘sleepwalk’ into retirement as there are now many more decisions you have to make about what you are going to do with your finances.
There is an overwhelming about of information available that aims to provide you with an overview of the choices available, however given the importance of the decisions you have to make at retirement we believe it is critical you take expert independent financial advice. This will provide you with specific recommendations that are ‘tailored’ exactly to your specific financial circumstances and retirement objectives.
How do I find out more?
Call us now on 0116 2592371 and we can arrange an appointment to conduct a thorough analysis of your Retirement Planning requirements and provide you with very specific and detailed recommendations.
The various retirement options are explained below:
Defer taking your pension and let it continue to grow
If you reach your selected retirement age and have sufficient income maybe because you are still working (part of full time) or you have other income from savings, investments or property rental – you could consider delaying using your pension fund.
This would allow your pension to continue growing to boost your income and provide a higher level of tax free cash (Pension Commencement Lump Sum) later in life for you and potentially your dependants. It may also be more tax efficient especially if your current level of income is set to reduce later in retirement.
It is important to remember however that your pension fund if still invested could fall as well as rise
When you retire, your pension fund finally becomes available to you. You can immediately take up to 25% as a tax free cash lump sum (called a Pension Commencement Lump Sum), and the rest is used to provide you with a regular income. Pension annuities are designed to give you a guaranteed income for the rest of your life – however long you live.
Once you have selected an annuity suitable to your circumstances, you cannot later change your mind and move funds elsewhere. That’s why it’s so important to get the best deal from the start.
There are two basic types of annuity:
1). A conventional annuity which either pays a specified income for a specified period – or for the rest of your life. The income you receive is fixed at the time you purchase the annuity. However, to help counteract inflation, you can specify that it increases in payment, either by a fixed amount or in line with a particular index, such as the Retail Prices Index (RPI).
2). An investment linked annuity
With an investment linked annuity, you will receive an income which will vary in line with the performance of an underlying fund. If, for instance, you choose a with-profits fund and the unit price of the fund increases, your income will rise. On the other hand if the unit price decreases, your income will fall.
Calculating your annuity income:
The income you receive from your conventional or investment linked annuity is dependent on a number of factors:
- Your age when you purchase your annuity
- The size of your pension fund
- The yield available on the underlying investments (usually fixed-interest investments such as Gilts or Corporate Bonds)
- Any additional benefits you select with your annuity
- Assumptions about your life expectancy made by the insurance company
- Taxation - Your income from a pension annuity will be treated as earned income and taxed under the Pay As You Earn (PAYE) system.
Annuity Options - click here to see our Guide to which Annuity
Payment frequency - How often you receive payments will affect the overall annual income you receive. In general, the higher the frequency, the lower the annual income. Your pension annuity can be paid according to your requirements and you can choose to receive the income either:
In advance or in arrears
You can also choose to have your income at the start of a given period – for instance at the beginning of the year or month – or at the end. So if you select monthly payments in advance, income payments would begin immediately on completion of your annuity purchase, and would continue to be paid at the start of each following month. In general, the income you receive for payment in advance will be lower than for payment in arrears at the same frequency.
Your annuity income is usually paid to you for the rest of your life. However you can specify that it is guaranteed to be paid for a specific period of up to 10 years. This ensures that should you die soon after taking out your annuity, your estate can benefit in a share of the pension funds you accumulated over your working life. In most cases the funds will be paid during the guarantee period by continuing installments. A guarantee period will reduce the annual income payable from your annuity.
You can choose to have your income increase each year, either by a fixed amount or in line with a particular index. This options helps protect your retirement income against the effects of inflation. Choosing to have your income escalate in retirement will mean accepting a lower initial income. In some cases the rate of escalation will be determined by legislation affecting pensions.
Spouses’ or dependants’ pensions
You can choose to have an income paid to your spouse or dependant in the event of your death. In this case the funds will continue to be paid to them for the remainder of their lifetime. You do not have to be married to the person you choose, but, if you are not, you will usually have to show that they are financially dependent on you. A dependant can be either of the same or opposite sex to you. Again selecting this option will reduce the starting level of your retirement income under the annuity.
An enhanced or impaired life annuity
If you have a medical condition, or a lifestyle factor such as smoking, you may qualify for an enhanced annuity. An enhanced annuity is designed to pay you a higher annuity income for the rest of your life. Access to your medical records may be required, and you may also have to attend a medical examination. The purpose of both is to determine the nature of your condition and the possible effect it may have on your life expectancy. This may take some time to arrange and assess, but may be worthwhile as you may qualify for a significantly increased income.
The potential advantages of annuities
- A lifelong income
- Peace of mind – no need to worry about your funds running out
- A conventional annuity provides a guaranteed income – no matter what happens in the stockmarket
- The opportunity at outset to tailor the income you receive to meet your specific needs
- An investment linked annuity offers the opportunity to obtain a more income from a given pension fund. - however this may result in reduced income if performance is below expectations.
The potential disadvantages of an annuities
- Generally, once selected, the level of benefits cannot later be adjusted so annuities are very inflexible (However the Government has announced changes (due to come into force from April 2016) that will allow you to sell your annuity for a cash lump sum if you circumstances were to change. The lump sum you receive will be taxable at your highest marginal rate)
- A conventional Annuity once purchased will not benefit from any future stockmarket growth
- If you select a spouse or dependant benefit and they die before you, the value of the income will be lost
- An investment linked annuity may result in reduced income if performance is below expectations
Income Drawdown (known as Flexi-Access Drawdown)
If you decide you don’t want to buy an annuity, one option is income withdrawal (commonly referred to as Income Drawdown). Income Drawdown is where instead of buying an annuity, you leave your pension fund invested and start to draw an income (you can still decide to buy an annuity at a later date).
There are a number of differences between income withdrawal from personal and occupational pensions, the information here only covers income withdrawal from personal pensions. Income withdrawal plans are complex and are not suitable for everyone. They are not usually a good idea if your pension fund is under £100,000 (after you have taken any tax-free lump sum) and you have no other assets or sources of income to fall back on. Even if you have a large pension fund, and other assets or income, income withdrawal may still not be suitable.
It all depends on the level of investment risk you are prepared to take. It is important to understand the advantages and the risks and to get expert advice. The decisions you make now will affect your pension income for the rest of your life (and that of any partner and other dependants).
How Income Drawdown works
Firstly, you may be able to take part of your pension fund as a tax-free lump sum. The maximum you can have is 25% of your fund, but it can be less. You then draw a regular income from what is left and this income is subject to income tax.
The pension fund will be reduced by the amount of income you take, and by the provider's charges and the potentially the cost of any ongoing financial advice your recive. The fund value will also rise or fall depending on the investment perforamce.
Regular monitoring of Income Drawdown plans is essential and we recommend you review your plan at least once each year. As your pension fund remains invested the hope is that the returns on your investments will make up for all or most of the charges and the amount you are withdrawing as income. If investment returns are lower than expected, you may find that your fund has fallen in value which may mean you have to accept a lower income in future (or a worst case scenario that your pension fund is totally depleted before you die)..
Because annuity rates usually rise with age, by postponing buying an annuity you could benefit from slightly higher annuity rates than you would have got if you had bought an annuity when you retired. But this cannot be guaranteed as annuity rates generally could fall. You can make changes to your plan such as varying the amount of income you are withdrawing, changing investment funds or buying an annuity. If / when you and your adviser decide the time is right, you can use the money that is left in your pension fund to buy an annuity from which you will get your pension income. The income withdrawal plan stops at this point. You do not have to use all your pension fund at once. Most personal pension funds are split into many smaller segments and you can decide to use just some of these, allowing the others to continue to be invested. This is a combination of phased retirement and income withdrawal and should be discussed with your financial adviser.
- You don’t have to buy an annuity when you retire especially if annuity rates are low. Annuity rates may increase with age.
- Your pension fund remains invested in a favourable tax environment.
- If you die before you buy an annuity, you can leave your pension fund to your partner and any dependants. They would be able to: take some or all of the remaining fund as a lump sum; carry on with income withdrawal; or take the fund and buy an annuity with it.
- You could reduce the amount of income tax you pay by adjusting the timing of your payments.
- While you receive the income, you gain the flexibility to vary income and the ability to control where the funds are invested. You are able to transfer your plan to another provider and continue income withdrawal. Your fund remains invested.
- There is no guarantee that annuity rates will improve in the future – they may go down. So you should not assume that you will get a better income by waiting. By delaying buying an annuity you lose the cross-subsidy generated by those who die before you buy an annuity. To compensate for this, your investments need to grow by an additional amount. This is called 'mortality drag'.
- Remember that with income withdrawal, you are taking money out of your pension fund and relying on investment growth to replace part or all of that you have taken. If the growth is not as high as you hoped for, your fund may get smaller and you will have less money to buy your annuity with, so you may get a lower pension income from it.
- You may have to monitor your fund more closely and make decisions or take advice more regularly. There may be charges for making this transfer.
- There will be conditions that need to be met before and after transfer. Not all providers accept transfers.
- If investment returns are lower than expected, you may find that your fund has fallen in value which means that you may have to accept a lower income in future.
- You also bear the risk that you may use up all of your fund before you die and run out of income.
Some of these advantages and disadvantages may not apply to you – it all depends on your personal circumstances. The advantages may make income withdrawal sound very attractive, but there are risks you should consider carefully before you make a decision.
Taking periodic (Ad-Hoc) small lump sums
Another option is to leave your pension pot invested and take out lump sums as and when you need them. The flexibility of these schemes will be entirely at the pension providers’ discretion so you may have to switch providers at retirement to take full advantage of these provisions. Unlike with Flexi-Access drawdown, your pension fund isn’t re-invested into new funds specifically chosen to pay you a regular income. You will have to make an active choice if you want to make fund changes and once again these may be limited by the pension provider (although we would envisage that these plans will increasingly provider a greater level of choice as this area of retirement planning develops) .
Whilst these arrangements are not designed to provide a regular income they will provide flexibility in how you access your pension funds. These arrangements will usually be more beneficial to people who want flexibility but where their pension fund is not large enough to opt for Flexi-Access drawdown. Please bear in mind that your pension fund will remain invested so the value can fall as well as rise. You also need to check your exact tax position before making withdrawals so you understand the implications and the income tax to which you will be liable.
Encashing your entire pension fund
This is where you wish to withdraw your whole pension fund straight away this closing your pension plan. The entire fund is paid as a ‘one-off’ lump sum with a quarter (25%) of payment being tax free and then income tax (at your highest marginal rate – after the addition of the withdrawal) being paid on the remaining fund. Great care needs to be exercised as full encashment of your pension plan could lead to a Higher Rate (40%) or even an Additional Rate (45%) tax charge.
Whilst this option gives you absolute flexibility in how you utilise your pension funds, obviously once spent, the money will no longer be available to provide you with income in retirement which was the prime objective of building up your retirement fund.
It is also important to understand that taking your entire pension fund as a lump sum (even after having spent the entire amount) could lead to you being refused state benefits later in retirement. The DWP Factsheet ‘Pension flexibilities and DWP benefits’ provides more information and we would strongly recommend you consider these potential implications before withdrawing your pension fund.
A combination of more than one option - tailing your retirement benefits
You don’t have to choose just one option, you can mix and match as you like, and take cash and income at different times to suit your needs. You can therefore tailor your pension lump sum/s and income withdrawals to exactly meet your circumstances, and fully take into consideration your attitude to risk, your age and changing health, the size of your pension fund and other savings as well as your other income. This solution will also provide total flexibility as your circumstances change throughout retirement.
There are many issues to consider, as your decision will affect your income for the rest of your life. You will need to get advice from a professional Independent Financial Adviser.
So why choose Provident Solutions to advise you on Retirement Options?
Depending on your experience choosing the right retirement options can be both complex and baffling. So the first thing we need to do is to undertake a detailed analysis of your financial circumstances and retirement plans. We can then help you choose the right retirement options and slect the best product provider and:
- Explain to you the difference between the various retirement options and the potential future alternatives.
- Explain the various options available in more detail.
- Assess your attitude to risk.
- Suggest the type of fund(s) that will suit you.
- Provide a regular review service (if you choose an option other than an Annuity)
How do I find out more?
Call us now on 0116 2592371 and we can arrange to visit you and conduct a thorough analysis of your Retirement Planning requirements and provide you with the appropriate recommendations.