Options at Retirement

Pension rules introduced on 6 April 2015 changed the pensions industry forever, freeing pensioners from the requirement to purchase an annuity with their fund and allowing them to decide when and how to take their pension; we look at retirement options.

Once they reach age 55, personal pension savers, can normally start to make withdrawals from their fund; up to 25% can be taken as a tax free lump sum, with any additional withdrawals taxed as income. This threshold will move to 57 from 2028.

There is no upper age by which retirement benefits have to be taken and therefore no requirement to take retirement benefits at all, should an investor wish to keep their pension invested.

What you do with your pension fund is a crucial decision and one that is relatively new, so with limited experience to call upon among your peer group that may be the time to take some advice to ensure that you understand your options and that your preferred option is the most appropriate for your individual circumstances.

To help to ensure that people were equipped to make informed decisions following last year’s pension freedoms, the government established Pension Wise to provide a free impartial service to anyone who requires it – online at www.pensionwise.gov.uk, by telephone at 030 0330 1001, or face to face.

Annuities

Annuity sales plummeted directly after the new pension freedoms were introduced, but have since rallied as despite relatively poor rates on offer, an annuity is one of the few ways of providing a guaranteed income in exchange for a pension fund.

An annuity delivers a guaranteed income for life, however long that may be, and can either continue to support beneficiaries after the investor dies or stop at that point, with rates adjusted accordingly.

Up to 25% of the pension fund used to buy an annuity can usually be paid as a tax-free lump sum and the rest taxed as regular income; the investor can choose whether the taxable income they receive should be fixed, increase by a set percentage over time or track inflation, again with an impact on the amount received.

A pensioner retiring with the lifetime allowance of £1 million in their pension fund which will be introduced in April may think they’re sitting pretty, but once they have taken a 25% tax free lump sum, the annuity they can buy will pay them around £25,000 in taxable income, below the national average full time salary of £27,500.

Income payments may be enhanced if the investor is subject to certain health conditions or lifestyle factors that may be detrimental to their longevity.

‘for the vast majority of customers, selling an annuity will not be the best decision’

It is also possible to guarantee the annuity for a minimum length of time, typically 5 or 10 years, so that if the investor dies within this period, income will continue to be paid to their estate, or a nominated beneficiary.

Previously, once an annuity had been established its terms were set in stone, options originally selected could not be changed and any change in the investor’s health could not be used to enhance future payments; ‘selling’ the annuity back to the insurance company attracted a tax charge of between 55% and 70%.

However, it has recently been announced that from April 2017 people who have bought an income for life with their pension pots will be able to reverse the deal by exchanging their annuity for a cash lump sum.

Around five million people have bought annuities, receiving a total income of £13bn a year, and they can now sell them and only pay tax at their highest marginal income tax rate.

One rule being announced as part of the new regulations is that an insurance firm will only be able to buy back an annuity from its own customers through an intermediary to ensure the customer shops around to get the best deal.

For some annuity sellers, independent financial advice will be compulsory if the sums involved are large enough and annuity purchasers and intermediaries will be regulated; however, the Treasury maintains that ‘for the vast majority of customers, selling an annuity will not be the best decision’.

Drawdown

Drawdown allows an investor to take a tax free lump sum in cash and keep the remainder of their fund invested, whilst drawing income directly from it.

This is more complex and higher risk than an annuity as the investor chooses where to invest, and the fund value will rise and fall depending on investment performance.

The investor retains control of how much they draw down from their fund, but anything taken out is taxable; as the ultimate manifestation of the new pension freedoms, the new environment does come with increased risk.

Unless the fund is entirely in cash or fixed income investments it delivers no guarantees in terms of income and poor investment performance or large income withdrawals can seriously erode, or potentially wipe out the fund’s value over time.

‘professional advice at retirement for even the most diehard DIY investor is rarely money wasted’

Generally it is thought that withdrawing 4% of a fund’s value every year is sustainable in terms of delivering an income throughout retirement, but it is a situation with so many variables that there can be no hard and fast rules.

The investor needs to satisfy themselves that their investment strategy is robust enough to maintain the fund at a level they need, for as long as they need it; any doubts may suggest revisiting the best buy annuity tables as an option that doesn’t keep you awake at night.

Death benefits are more favourable than under an annuity because no decisions need to be made before applying to move the fund into drawdown; drawdown pension funds can be inherited by any nominated beneficiary and can normally be withdrawn tax free if the original investor died before age 75, or subject to income tax if after.

Uncrystallised Funds Pension Lump Sum (UFPLS)

UFPLS is an option which allows periodic lump sums to be taken directly from a SIPP without having to move the pension into drawdown.

Each time a lump sum is withdrawn, 25% is tax free and the rest taxed as income; the decision whether to withdraw income over time rather than in one lump sum is an important one, and can affect the amount of tax paid.

The remaining pension fund stays invested, so its value and future income is not guaranteed although it does create potential for growth; however, taking lump sums reduces what is left to provide income in the future, particularly if the investments perform badly or too much is withdrawn.

Hybrid Strategy

Taking benefits from a pension fund is not all one thing or another; there is no requirement to take everything in one go, so investors do not need to make a definitive choice between one course of action and another.

It is possible to decide upon a mix and match approach, for example using some of a pension fund to cover essential living costs by buying an annuity, and using the remainder to provide an additional and flexible income.

With such potentially wide disparities in terms of outcome, professional advice at retirement for even the most diehard DIY investor is rarely money wasted.