Until recently there was limited scope when considering your best pension options. All that changed with the new pension freedoms (effective April 2015). In this post, we consider the four main pension strategies for those over 55.
Since the reforms, pension drawdown (also known as income drawdown) has been the subject of most people’s attention. The control offered by drawdown and its flexibility does make it an attractive option for some but it is important to compare and contrast it with more traditional options as part of a retirement planning exercise. Remember, Pension Drawdown is not necessarily a stand alone option but can be combined with other pension options (or other options such as an ISA) to deliver the best return from your available pension fund while minimising risk.
There are four basic pension options:
- Flexi Pension Drawdown.
- Guarantee a fixed income for your lifetime income using an annuity.
- Take all, or part, of your pension as a cash lump sum.
- Leave your pension pot untouched.
There are serious tax implications, particularly with option 2, so you should consider your best pension options carefully. It is also important to be aware that pension legislation can change. Nobody can be certain what the future of pensions may be.
The Pension Drawdown Option
Pension drawdown gives you more control both in how you take your income and how the balance is invested. It is also possible to pass on any remaining pension fund when you die to your spouse or children. However, although high inheritance tax charges (up to 55%) were removed in April 2015 there are still tax implications on inheritance that should be considered.
In pension drawdown, your pension fund is usually transferred into a defined contribution pension (often a SIPP) scheme which you then manage going forward. A SIPP can accept a wide range of assets and you are responsible for managing those investments to maximise growth while minimising risk. You may draw on your pension fund as you wish.
There are of course also major risks. You are responsible for managing the investment and bad decisions can have a serious impact on your available fund. Also, investment returns can be volatile, so the value of your pension fund can fall. If you do not manage your income appropriately there is a risk you could outlive your pension funds.
It is important you do not lose out on any valuable benefits when considering drawdown. It may be best to leave pension funds where they are rather than make a transfer. You should always ensure you read your policy documentation carefully and consider any charges and fees that may apply.
The Annuity Option
In contrast, annuities guarantee a fixed income for life. You cannot outlive your pension fund, however long you live. ‘Joint-life’ annuities will also pay a spouse a pension until they die. An Annuity therefore provides a lifetime guarantee but there is no value to potentially pass on to children and the pension income is fixed.
Annuity rates are currently relatively low. It is important to carefully compare and contrast the Annuity option with drawdown when deciding on your best pension options. At present, once you buy an annuity you can’t switch back at a later date, or transfer to another annuity product. It is, however, possible to convert whatever remains in a drawdown fund to an Annuity at some future date.
Take A Cash Lump Sum
You can take all your available pension fund as cash and for smaller funds, this may be beneficial. As only the first 25% is tax-free it is vitally important to consider the tax position. Personal circumstances, such as ill health, may make cashing in a viable option but it is important to have a solid plan of exactly what you will do with the funds. Taking any income or tax free sums from a pension is not possible until the pension holder is at least 55 years old.
You may decide not to take your pension and to carry on working for longer or continue working but at reduced hours. If you do continue working you may decide to continue making contributions to your pension plan. Your pension fund will then continue to grow tax-free until you need it, potentially providing more income once you do retire.
If you want to build up your pension pot you can continue to get tax relief on pension savings however contributions may be restricted depending on how you have accessed your existing plan. However, it is important to consider carefully what will happen to your pension fund should you die before accessing the fund.
Take No Action
Leaving your pension fund untouched and with your current provider may be the best course of action. The pension scheme may offer valuable benefits that would be lost if the pension were moved. It may offer investment returns at or above the industry average that would be difficult to match elsewhere. Personal circumstances such as the length of time to retirement may dictate it is best to stay where you are.
Should you wish to discuss your best pension options and what may be the best way forward given your specific circumstances then please do not hesitate to give us a call on 0800 0843 8341 for a (no obligation) initial chat. Alternatively, complete the contact form below and we will call you. We are authorised and regulated by the FCA and operate UK wide.