Choices At Retirement - Your Options
You need to understand all your options when coming up to retirement.
At retirement, your options are:
- Pension Annuity - for a guaranteed income for life
- Capped and Flexible Drawdown if you do not want to buy an annuity
- Phased Retirement
- Tax Free Cash Lump Sum and a reduced pension or not?
Speak to our advisers today about your retirement options.
1. Pension Annuity - Open Market Option - A Guaranteed Income for Life
When you come to retirement age with a pension scheme, some or all of the fund that has been built up either in your own name or in your employers pension scheme is used to buy a Compulsory Purchase Annuity. This is a guaranteed pension income for life. There are many choices within the annuity as well as whether to take a tax free lump sum or not.
Choice of Company - The Open Market Option Annuity
- If you have a investment linked (money purchase) pension scheme, you do not have to take the annuity with the provider of your original pension. You can normally choose the best Annuity rate for you by using an Open Market Option Annuity and shopping around.
- An open market option annuity gives you the right to shop around with your pension fund to obtain the best rate of annuity income you can for your retirement.
- This is not the case for final salary schemes as your retirement benefit is normally guaranteed and the problem will rest with the pension scheme trustees who will normally buy the annuity pension benefit (which is guaranteed) on your behalf. It is this annuity that will provide you with income in retirement and you can choose different ways for it to be paid. What you include will determine how much annuity pension income you get for your pension fund money.
How much pension income will I receive?
The amount of annuity paid in return for the value of a pension fund can be affected by the following issues:
- Low interest rates mean low Annuity rates. This means you will get less for your money.
- High interest rates mean high Annuity rates. This means that you will get more for your money.
- We have been in a period of low interest rates and increased life expectamcy for many years now meaning that annuity rates have fallen since the 1980's, even to the point where the Government introduced new flexible pensions access
- Other factors can also affect the amount of annuity pension income such as benefits for partners, tax free cash sums taken, increasing annuity income and more. Book a callback and discuss your options today.
2. Pension Drawdown - Capped and Flexible Drawdown - Flexible Pensions
- Capped or Flexible Drawdown Income (income drawdown or pension fund withdrawal as it used to be called).
- With effect April 2015 all drawdown is called Flexible Drawdown or Flexible Pensions. From April 2015, there is no longer a requirement to buy an annuity income by age 75, (you can still take an annuity if you wish) but many people are opting for flexible drawdown pensions
Flexible Drawdown means that you have not bought a guaranteed income for life i.e. you have not secured/bought a pension annuity. Using the drawdown option
- Leave the pension fund invested to hopefully achieve some further investment growth
- Withdraw some or all of your tax free cash entitlement from the fund
You Withdraw income from the fund when needed from the pension fund:
- Flexible Pension - with no limits on the amount you can withdraw from your pension fund (After April 2015)
- Capped drawdown with income limits (before April 2015) or flexible drawdown limits if you have enough pension income already (must have guaranteed i. This can be regular income or irregular income.
Flexible Pension and the Old Style Capped Drawdown products are aimed at:
- Individuals aged 55 and over
- Those who wish to release the tax free cash only and leave their pension fund invested
- Those who do not want to buy an annuity
- Larger pension fund owners
- Those who prefer a more flexible and controlled approach to their pension planning
- Those who wish to choose between zero income and normal income levels and increase or decrease these income levels at different points
- Those who wish to protect some of their pension fund on death for their loved ones
- The capped drawdown rate increased to 120% of GAD rate.
- What is GAD? The Government Actuaries Department (GAD) sets a 'standard annuity income rate', based upon published gilt yields and annuity rates for different ages. The GAD rate was/is used to calculate the maximum income that you can then drawdown from a capped drawdown pension plan.
- After intense lobbying from the pensions industry, the government confirmed the Increase the maximum income allowed under capped drawdown from 100% of GAD to 120% of GAD
- It applies to all new capped drawdown pensions set up after 25th March 2013 (i.e. it starts on 26th March)
- For existing drawdown schemes, the ability to increase income did not apply until you reach your pension scheme anniversary date, on 26th March 2013 and thereafter.
- Why did this happen? Annuity rates have fallen dramatically over the last few years and when existing pension drawdown members reached their 5 year drawdown review date, because annuity rates had fallen, the GAD standard rate had fallen, meaning people were suffer pay cuts in the maximum drawdown they could withdraw from their pension fund, even if their fund values had remained constant or grown in value.
Flexible Pension Drawdown (and the older style capped drawdown) is a higher risk retirement option as you remain invested which means your pension fund value can fall as well as rise and we suggest you take advice from us before considering such a retirement strategy.
3. Phased Retirement - Retire in stages
Phased Retirement, sometimes known as "staggered vesting", does what you think it does, it manages your retirement in stages.
Phased Retirement is aimed at individuals aged 55 or over with a significant pension fund who would prefer a more flexible and controlled approach to their retirement planning.
How does phased retirement work?
- The retirement pension fund is divided into a number of identical policies within the plan (normally 1,000 separate mini-pensions).
- You encash/retire on the required number of mini-pensions in phases to utilise the tax free cash and retirement annuities on a yearly basis.
- The retirement annuities provide ongoing retirement income for life and can be purchased on a different basis each year.
- The more mini-pensions you encash, the greater your retirement income, i.e. you gradually phase in your retirement to being fully retired
- With phased retirement, you can retire in full at any time after age 55
Positive Features of Phased Retirement
- By taking the tax free cash on an annual basis for retirement income purposes you can manage the amount of Income Tax payable, and possibly keep marginal rates of tax to a lower level than may have been possible using the conventional retirement annuity route.
- The balance of the fund which is not utilised to purchase annuities, remains invested in the tax privileged pension funds. This may lead to a potentially higher retirement income at age 75 than could have been purchased via the retirement annuity route at outset.
- As you get older, there is a possibility that annuity rates will improve, and this may mean a higher retirement income at age 75, or earlier, than could have been purchased at outset.
- With phased retirement, the amount of retirement income required can be varied annually, either upwards or downwards to meet your needs, and to fit your income situation. Any annuities that have already been purchased from encashing the policy segments cannot be altered.
- It is not necessary to encash segments every year for use as tax free cash or annuity purchase. You can defer encashment if you wish to.
- Different annuity structures can be purchased each year with phased retirement policies. For example, you could buy an increasing annuity one year, and a level annuity for the following year, enabling you to adapt the retirement income. This flexibility also means that you can adapt annuity purchase to suit changing circumstances i.e. death of your spouse.
- With phased retirement, annuities can be purchased with the provider offering the highest annuity rates each year, using the Open Market Option.
Negative Features of Phased Retirement
- The ultimate pension may not be as high with phased retirement as the conventional annuity that could have been purchased at outset. This could be the case where, for example, interest rates fell for a period of time. There is no guarantee that annuity rates will improve over time.
- The tax free lump sum available at outset with phased retirement may be restricted as it is determined by the number of policy segments encashed. The remaining segments when encashed will provide small amounts of tax-free cash. However, these are normally utilised on an ongoing basis to provide income.
- Annuities are normally purchased each year, and this may mean that annuities are purchased at a time when rates are not favourable, or the underlying investment values may be depressed. It is however possible to exercise a degree of control over the timing of the purchase.
- The withdrawals of tax free cash and funds to purchase the ongoing annuities could erode the value of the funds remaining. The remaining fund may also be at risk from adverse investment conditions and charges.
- With phased retirement, retirement income is not finally secured, and is therefore not guaranteed. You may feel that this lack of guarantee is not acceptable.
There are many other factors that can affect the advice on whether someone is suitable for pension phased retirement, whether to use a combination of phased annuity purchase and pension fund withdrawal or other combinations.
Phased retirement is rewarding but can be complex. Contact us for expert pension advice on phased retirement.
4. Lump Sum and Tax Free Cash Options
When you reach retirement most pension funds offer you the ability of taking part of your pension fund as a tax free cash lump sum. This is usually 25% Tax Free Cash.
A change in pension rules in April 2006 means that all pension funds now have a limit 25% of the fund value of the pension as the maximum tax free cash lump sum. The balance must be used to provide you with an income. The remaining 'income' fund can either be taken in lump sums via flexible drawdown of pension funds (option 2 above) when you need it or can be used to buy an annuity (option 1 above)
If you have a pension fund that has a 'protected' higher tax free lump sum at retirement option, you should read the transitional rules.
Larger Tax Free Cash Lump Sums: Transitional Rules
Some pension funds that were in force before April 2006 may have tax free cash sums that are greater than 25%. These higher tax free cash sums may need to be protected. We suggest you read the section below on Transitional Pension Rules or contact us for pension advice.
Transitional Rules - From August 2014 through to April 2015 - you are/were allowed to transfer your pension in its entirety to a new pension plan provider and still protect any higher tax free lump sum that you may be entitled.
Should I take a tax free cash lump sum?
In our view, the decision to take a tax free cash lump sum is personal and will differ for each of us, although the following pointers may help:
- Tax Free Cash means what it says the cash is not subject to income tax when you receive it although where you then invest the tax free cash may be subject to tax unless you invest it in tax efficient areas.
- If you leave it inside the pension for a bigger pension income, the majority and normally your entire pension income is treated as taxable income.
- Some older pension schemes, but only the lucky few, have Guaranteed Annuity Rates that offer very high income returns.
- You need to compare the annuity income rate offered to the investment return you could receive if you withdraw cash
In simple terms, one route is definitely taxable the other may not be if you invest wisely. The decision on whether to take the lump sum is considered later, but we suggest you work out the difference between the higher income (with no lump sum) and the lower income with the lump sum taken. Divide the difference/fall in income by the lump sum and multiply by 100. This will give you the % income yield. Some pension companies may offer higher income yields. If you income yield is say 5% or 6% from the pension, it may be that you will not receive that same rate of return if you withdraw the lump sum. It is then a question of should I take it or not? You are gambling on your life expectancy and how long you would have to live and receive the income compared to withdrawing it all out today.
Tax Free Cash Sum Only Option
There is also flexibility to be able withdraw the tax free cash sum only from your pension fund and leave the pension fund invested. This is part of the new pensions flexibility under Flexible Pension Income Rules.
If you need help on a decision whether to take tax free cash or not, take advice from us.