Introduction to Your Pensions at Retirement Options

When getting close to or reaching your chosen retirement age, it presents us all with probably the largest or second largest most important financial decision of our lives.  Decisions that you make at retirement affect your finances for the rest of your life and your partner or loved ones if you have them.

Firstly, you need to understand what your needs will be in retirement.

Minimum ‘Subsistence’ Secure Income

We believe that you should draw up a list of your likely expenses in retirement i.e., how much subsistence income do you need to pay all your bills, feed and clothe yourself?  Once you know this figure as well as allowing for inflation increases in the future, you have your minimum income target.

We believe you should have a minimum of at least your subsistence living expenses covered by secure income.  Secure income means guaranteed income for life that does not rise and fall when markets do, it is guaranteed and hopefully increases each year with inflation.

Types of Secure/Guaranteed Income:

• The State Pension.
• Defined Benefit Pensions:  Final Salary or Career Average Salary linked pensions – these are now usually only available from larger employers or central and local government type employers such as Armed Forces, NHS, Teachers, Civil Service etc.  Most people are advised to keep their defined benefit pension and lump sum (as they are guaranteed, rather than give them up and transfer to an investment linked/non-guaranteed pension fund).
• Annuities:  These give a guaranteed income by paying a lump sum to the annuity provider and can be bought either buy you investment linked/defined contribution pension fund or by investment in a purchased life annuity.

Defined Contribution and Investment Linked Pensions for Fun/Leisure Money

Many employers offer defined contribution/investment linked workplace pensions, the more you save, the bigger the pension pot you build up.  Examples of popular defined contribution schemes (there are more):

• Workplace Pension.
• Stakeholder Pension.
• Personal Pension Plan (PPP).
• Self Invested Personal Pension Plan (SIPP).
• Small Self-Administered Scheme (SSAS).

Retirement Options for Defined Contribution Schemes

Optional Tax-Free Cash usually 25% of the fund value – you can usually take this in full, in part or even choose not to take any tax-free lump sum.  Tax-Free cash is now capped at a maximum 25% of fund value and capped overall during lifetime at £268,275 (lump sum allowance).  The balance is then used for taxable pension income or capital as follows:

• Annuity Income
• Standard annuity rate for those with normal life expectancy or Enhanced annuity for those with life shortening medical conditions and smokers.
• Can be a secure (guaranteed) conventional annuity or non-guaranteed investment linked annuity for income.
• Level or increasing by % or inflation income options.
• Whole of life or fixed term with optional early death guarantees and surviving spouse benefits.
• Unless you have a spouse’s benefit built in, the annuity ends when you die.
• Once the annuity is bought, you cannot convert it to any other type of ‘at retirement’ product.
• Flexible Access Drawdown
• Pension funds remain invested to grow.
• You can drawdown as much or a little as you want at any time.  This can be regular withdrawals or ad hoc withdrawals.
• You can use drawdown as a flexible approach to early retirement in bridging any income shortfalls for when secure income starts such as state pensions etc.
• You can convert drawdown to an annuity at any time.
• The balance of your pension fund on death can be left to spouses or loved ones although this may be subject to inheritance tax from 2027.
• Fully Cash In
• First 25% is usually tax free, the balance is subject to income tax.
• Small pots rules:  If the value is under £10,000 you can usually cash this in easily and the pension provider will automatically withhold 20% income tax.  If you are non-taxpayer, you may be able to claim a tax refund.  If you are a basic rate taxpayer, no further tax will be payable.  If you are a higher rate taxpayer, further income tax may be payable.
• Over £10,000 cash in = UFPLS – Uncrystallised Fund Pension Lump Sum.  You can cash in larger amounts of pension fund or the whole fund if you wish.  This will have withholding taxes and have taxes deducted as if you were receiving the whole amount cashed in every month.  Huge withholding taxes will apply/  E.g., if you cash in a pension pot worth £30,000, it will have withholding taxes applied as if you were receiving £30,000 per month i.e., £360,000 pa and have withholding taxes of up to 45% applied.  You can then apply for a tax refund from HMRC where/if you have overpaid income taxes on the withheld amount.

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