Accessing Your Pension – Which Method Is Best?
Gone are the days of the traditional annuity purchase at retirement – there are now more options than ever available to individuals choosing to retire.
But accessing your pension income can be complex – determined by your personal circumstances, your tax-position, when you want to stop work and how you feel about investment risk. No two individuals will have the same retirement and there is no one-size-fits-all approach.
Stopping work in its entirety, or choosing to wind-down, is normally one of the biggest life decisions that you will make. Should you choose the security, but relative inflexibility of an annuity, or access your fund bit by bit, with the danger of stock market volatility impacting on how long your pension might last for? Can you do both?
We’ve detailed some of the most common methods of how to access your money purchase pension, to give you an idea of the options available. But remember – not every pension policy or scheme will offer every option.
Good financial planning advice is the best way of making sure you pick the right option for your circumstances. We are here to help – book your free consultation with us today.
Annuity Purchase – A Guaranteed Income
While the introduction of Pension Freedoms means more choice, using your pension fund to buy an annuity is still a great option for some individuals.
Provided by insurance companies, the amount of income you can receive will depend on the value of your available pension fund, your age, the type of annuity you choose and annuity rates at the time.
Annuities can be tailored to your individual circumstances and there is a wide range of choice available. You can elect to take tax-free cash, choose level or increasing income payments, and include provision to protect your spouse should you pass away. Each of these additional options can reduce the amount of starting income you receive, but the income is guaranteed for the term of the plan – either for a specified amount of time, or indeed, the rest of your life.
An annuity purchase may be a suitable option if you do not feel you are confident investor, or worried about how long your pension may last for. A guaranteed income can provide peace of mind in later years, rather than worrying about stock market performance.
But annuities can be inflexible, and you cannot change your mind once you buy. If you need more or less income in retirement, you cannot increase or decrease your annuity payments once the policy has been set up. If you have other income sources in retirement, your income tax position may be adversely affected. Or worse – you might not have enough money to meet your lifestyle needs, even if the income is guaranteed. Inflation can also erode the value of a level annuity. Whereas increasing annuities help counter this, there may be concerns about having your highest income at your oldest age when mobility may be impaired.
Taking A Cash Lump Sum – A Little, A Lot, or The Whole Pot
You can access some, or all, of your pension pot as a cash lump sum.
Under usual rules, you can access 25% of your pension policy as a tax-free lump sum. You might use the lump sum for home improvements, paying off your outstanding mortgage or helping out younger generations of your family. The rest of your pot can either be used to purchase an annuity or designated to a drawdown account where it will remain invested for future growth. You can access your lump sum from age 55 (increasing to 57) – but it will reduce the amount of leftover savings you can use to provide your retirement income.
You can take a series of tax-free lump sums – you do not need to take the whole 25% in one go. Each time you access some of your tax-free cash, your pension fund is ‘crystallised’ and the proceeds of the crystallisation are held separately in a drawdown account, away from the funds you haven’t touched yet.
You can also take the whole of your pension as a cash lump sum – but the remaining 75% will be taxed at your marginal rate of income tax. If your pension pot is very large, you could end up with a very high tax bill if you withdraw the whole of the pension in one go.
Taking the entirety of your pension pot as a lump sum would only be suitable in very specific circumstances – pensions offer a very tax-efficient environment in which to grow your wealth. Taking the whole of your fund out of the pot can have consequences on not only your tax bill, but how much money you can put into a pension in future, inheritance tax concerns if you pass away before you have spent the money, and whether you have anything else left to provide your income in retirement.
Uncrystallised Funds Pension Lump Sum – A Tax Efficient Mouthful
If you need an ad-hoc income payment, or series of payments, the inelegantly named Uncrystallised Funds Pension Lump Sum, or UFPLS, is a further method of accessing your pension fund.
Instead of designating some of your pension pot to a drawdown account, or purchasing an annuity, an UFPLS will allow you to take benefits from your uncrystallised pension fund only. The first 25% of the income payment is tax-free – think of it as a small tax-free cash payment. The rest of the income payment, the remaining 75%, is taxed at your marginal rate of income tax. In a similar manner to taking only your tax-free cash, the rest of your pension pot remains invested for future growth.
UFPLS payments can be useful if you have no other taxable income in a given year and allow you take advantage of your personal allowance. In some cases, this may mean that no tax is payable.
But care must be taken – an UFPLS payment affects how much you can put into a pension in future and might not be suitable if you are planning on continuing work. Emergency tax may also be applied, and some pension providers might apply this each time you access your pension fund in this manner, even if they are aware of your current tax code.
Flexi-Access Drawdown – The Importance Of A Sustainable Income Strategy
Flexi-Access Drawdown offers the most flexibility on how you access your pension fund. Income is taken from your drawdown account – there are no limits on how much income you can take, and you can increase, decrease, or even cease taking withdrawals depending on your circumstances in retirement.
Flexi-Access Drawdown is particularly useful if you are planning on phasing in retirement – for example, if you want to work part-time, or switch to a lower-paid, less stressful role, you could ‘top-up’ your income until you stop working altogether. Pension withdrawals can then be increased at a later date when you eventually decide to stop work.
Flexi-Access Drawdown can also be useful if you have several sources of income in retirement, helping to bridge the gap between a final salary pension start date, or your state pension entitlement at state pension age. Income withdrawals can be decreased as these other income sources come into payment.
Income tax will be applied to your withdrawals if your total income is in excess of your income tax personal allowance, so consideration must be given to other income you may receive and if your proposed withdrawals push you into a higher tax bracket. As you will be taking income from your pension, and not just tax-free cash, this will also impact on how much money you can continue saving within a pension plan.
While Flexi-Access Drawdown offers great flexibility, the fund is still invested and is therefore wholly vulnerable to market performance. Drops in the value of your investment fund could have a significant impact on how much money you can withdraw each year and it is vitally important to monitor your fund to ensure it will last for the rest of your lifetime.
A seemingly unlimited pot of money is attractive to most people; you are suddenly in a position where you could feasibly take an income larger than what you earnt from working in the previous year. But taking large income payments in the earlier years of retirement may mean you run out of money later. Should you have an increased life expectancy, or suffer from repeated investment losses, you may find yourself in a position where you can no longer meet your basic cost of living, or fund long-term care costs in your later years.
Financial planning is essential to ensure a sustainable withdrawal strategy for the years ahead.
So Which One?
There is no one right answer when it comes to picking a retirement income strategy – in fact, a combination of various methods could be the best option. But there are a great number of obstacles to navigate, including tax, budgeting, forecasting, stock-market worries, and shortfall planning, which does not make stopping work any less scary. On the plus-side there may be opportunities to save tax with clever application of your tax-allowances.
And in the midst of all the uncertainty, there is also the concern that your pension savings are invested in industry that is not aligned to your ethical principles and could be harming both people and planet.
But we are here to help. We can build a retirement plan unique to your circumstances and you can be safe in the knowledge that our expert financial planners can take away some of the stress of retirement planning – meaning you can concentrate on the important things.
We at Path Financial pride ourselves on our sustainable positive impact investment strategies. Investing with us will help build a better world for you to retire into.
To find out more about how we can help you, and help people and planet, book your free consultation today.
About the author
Casey has been working within the Financial Services sector for 6 years, having recently completed her Chartered Insurance Institute Diploma in Regulated Financial Planning. A passionate paraplanner, Casey was inspired by our vision to provide quality financial planning advice whilst being at the forefront of making a positive financial impact in the world. Having a personal interest in ethical investing, Casey knew that this was possible without having to sacrifice good returns.
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