When greater pension flexibility was introduced in 2015, the level of freedom it gave pensioners was welcomed. However, with Pension Freedoms comes far more complexity and responsibility for retirees today. Understanding your options and how they’ll affect your lifestyle is essential for a modern retirement that meets expectations.
The reforms introduced four years ago were the biggest pension shake-up in a generation.
One of the changes the reforms brought in that caught the attention of many retirees was the ability to take a 25% lump sum of a pension tax-free, known as a pension commencement lump sum. This doesn’t use up any of your Personal Allowance (£12,500), providing many retirees with greater freedom in early retirement.
In the past, most retirees would create an income in the same way. Once you reached retirement age you used the money accumulated in a Defined Contribution pension to purchase an Annuity, which would then pay out a set income for life. Today, an Annuity is still an option but it’s far from the only one you have.
In fact, figures from the Financial Conduct Authority show Annuities are no longer the most popular way to access pension savings. The latest data available, covering the period between October 2017 and March 2018, found:
With more routes to explore and retirement being more flexible than ever, advice can really add value. Yet, research from the Association of British Insurers (ABI) revealed that a third of people accessing their pension have never taken any advice. It’s a decision that could put a lifetime of savings at risk just as it’s needed most.
What are your pension options?
The first step to choosing the right type of retirement income is to understand what your options are.
Take lump sums: You can take chunks of a pension out until it’s depleted, how much and when you do this is up to you. If you choose this option, the 25% tax-free amount isn’t paid on one lump sum. Instead, each time you make a withdrawal, 25% of it will be tax-free, the rest may be liable for Income Tax. You should carefully consider tax liability with this option and the sustainability of withdrawals.
Purchase an Annuity: With a Defined Contribution pension, the only way to create a guaranteed income for life is to purchase an Annuity. In return for a lump sum, an Annuity provider will pay a defined amount at set intervals. It’s a product that can provide you with financial security and certainty in retirement. It’s possible to link an Annuity to inflation, maintaining spending power as the cost of living rises.
Get an adjustable income: If you want more flexibility to access your pension, an adjustable income may be right for you. Using Flexi-Access Drawdown allows you to take a regular income which can be increased, decreased or paused as needed. The money held in Flexi-Access Drawdown will typically be invested. Whilst it’s a route that offers more freedom, you need to take more responsibility for ensuring pension savings last a lifetime and to manage potential investment risk.
Withdraw your whole pension: A pension can be completely depleted by a single withdrawal. This may be the right choice in some circumstances; however, you need to consider how other assets or pensions will be used to support you throughout retirement. Another factor to keep in mind here is the potential tax liability. Only the first 25% of a pension can be withdrawn potentially tax-free, the rest will count as income. As a result, it’s usually not the most tax-efficient way to access savings.
Leave your pension where it is: You don’t have to access your pension at any point in your life. Should you choose to, it can remain where it is. If Inheritance Tax (IHT) is a potential issue, this option can have benefits and reduce tax liability. Typically, a pension is considered outside of a deceased estate for IHT purposes. If you die before the age of 75, in most cases a beneficiary can make withdrawals from a pension tax-free. After the age of 75, they may need to pay Income Tax at their usual rate.
Remember, you don’t have to choose just one of the above options. Should it suit your lifestyle and needs, it is possible to blend them to create a hybrid solution. For instance, one retirement income option may be to:
Bringing in other assets
Whilst pensions are the focus of retirement savings, other assets you’ve built up over your lifetime can also be used to supplement the income a pension will deliver. As you plan your retirement finances, it’s important to include this to gain an accurate picture of overall wealth and what’s possible in retirement. Assets to consider may include:
Bringing together multiple income streams can be complex, as can deciding how and when to use them. Not only do you have to consider the long-term impact of depleting assets, but other areas too, such as potential tax liability and how assets complement estate planning. However, it’s a crucial step when financially planning your retirement.
If you’re approaching retirement and aren’t sure which income option best suits personal aspirations and goals, please contact us. We’re here to help you create an income that will match your desired lifestyle now and in the future.
Please note: A retirement is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
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