How to ensure a comfortable retirement
The pension freedoms have given retirees a whole host of new options. There is no longer a compulsory requirement to purchase an annuity (a guaranteed income for life) when you retire. The introduction of pension freedoms brought about fundamental changes to the way we can access our pension savings.
Once you reach 55, you can access your pension pot. You can take some or all of it, to use as you need, or leave it so that it has the potential to continue to grow. When you take your pension, some will be tax-free but the rest will be taxed.
The amount taxable will depend on your circumstances, which can change. Tax rules can also change in the future. It’s up to you how you take benefits from your pension pot. You can take your benefits in a number of different ways.
Choosing which method
You’ll need to choose which method you use to do so, with options including: buying an annuity (a guaranteed income for life), taking income through flexi-access drawdown, withdrawing lump sums or a combination of all of them.
There are advantages and disadvantages to each method, and in some cases your decision is permanent.
Which option or combination is right for you will depend on:
> Your age and health
> When you stop or reduce your work
> Whether you have financial dependents
> Your income objectives and attitude to risk
> The size of your pension pot and other savings
> Whether your circumstances are likely to change in the future
> Any pension or other savings your spouse or partner has, if relevant
Everybody’s situation is different, so how you combine the options is up to you.
Annuities – guaranteed income for life
Annuities enable you to exchange your pension pot for a guaranteed income for life. They were once the most common pension option to fund retirement. But changes to the pension freedom rules have given savers increased flexibility.
You can normally withdraw up to a quarter (25%) of your pot as a one-off tax-free lump sum, then convert the rest into a taxable income for life – an annuity. There are different lifetime annuity options and features to choose from that affect how much income you may receive. You can also choose to provide an income for life for a dependent or other beneficiary after you die.
The amount you receive can vary. It depends on how long the provider expects you to live and how many years they’ll have to pay you.
Flexible retirement income – pension drawdown
When it comes to assessing pension options, flexibility is the main attraction offered by income drawdown plans, which allow you to access your money while leaving it invested, meaning your funds can continue to grow.
This option normally means you take up to 25% of your pension pot, or of the amount you allocate for drawdown, as a tax-free lump sum, then re-invest the rest into funds designed to provide you with a regular taxable income.
You set the income you want, though this might be adjusted periodically depending on the performance of your investments. You need to manage your investments carefully because, unlike a lifetime annuity, your income isn’t guaranteed for life.
You may be able to ask your pension provider to invest your pension pot in a flexi-access drawdown fund. If you have a ‘capped’ drawdown fund, you can keep it or ask your pension provider to convert it to flexi-access drawdown.
Small cash sum withdrawals – tax-free
This is an important consideration for those weighing up pension options at age 55, the earliest age at which you can take up to 25% of your pension pot tax-free. You should ask yourself whether you really need the money now. If you can afford to leave it invested until you need it then it has the opportunity to grow further.
For each cash withdrawal, the remaining counts as taxable income and there could be charges each time you make a cash withdrawal and/or limits on how many withdrawals you can make each year. With this option, your pension pot isn’t re-invested into new funds specifically chosen to pay you a regular income and it won’t provide for a dependant after you die.
There are also more tax implications to consider than with the previous two options. So, if you can, it may make more sense to leave your pension pot to grow so you can enjoy a larger tax-free amount in years to come. Remember, you don’t have to take it all at once – you can take it in several smaller amounts if you prefer.
Combination – mix and match
Of all the pension options, if appropriate to your particular situation, it may suit you better to combine those mentioned above. You might want to use some of your savings to buy an annuity to cover the essentials (rent, mortgage or household bills), with the rest placed in an income drawdown scheme that allows you to decide how much you can afford to withdraw and when.
Alternatively, you might want more flexibility in the early years of retirement, and more security in the later years. If that is the case, this may be a good reason to delay buying an annuity until later in life.
The value of retirement planning advice
There will be a number of questions you will need answers to before deciding how to use your pension savings to provide you with an income.
> How much income will each of my withdrawals provide me with over time?
> Which withdrawal option will best suit my specific needs?
> How much money can I safely withdraw if I choose flexi-access drawdown?
> How should my savings be invested to provide the income I need?
> How can I make sure I don’t end up with a large tax bill?
Tax on your pension
When you receive money from a pension, you pay tax on any income above your tax-free personal allowance.
Your pension provider will take off any tax you owe before you receive money from your pension pot. You may have to pay a higher rate of tax if you take large amounts and you may owe extra tax at the end of the tax year.
Top 5 things to consider before withdrawing money from your pension
1. Pensions freedoms: Familiarise yourself with the pensions freedoms so you are aware of your options. You can now do a lot more with your pension pot than previously. Everyone is different and it is important to find the right solution for your circumstances. What risks are you willing to take?
2. Saving requirements: Consider the amount of money you will need each month to maintain your lifestyle. Ask yourself: How much might I need? How much might I get? Do I still have a mortgage to pay off? What other sources of income do I have, and do I need my pension to keep up with inflation? Could I consider working for longer? Do I want to have annual holidays?
3. Costs later in retirement: Think about costs later in your retirement. What will your living costs be in the future? Care needs are not a subject we are comfortable thinking about but it is important to have conversations about it with your family, as well as Powers of Attorney, Wills and inheritance.
4. Health and life expectancy: We often vastly underestimate this, but evidence shows we are mostly living longer, with a growing variation in healthy life expectancy. If you have a partner, do you need to provide for them financially after you die, or are you relying on them?
5. Obtain professional financial advice: Few of us may expect to give up work altogether in our 50s. But a growing number of us are dipping into our pension before retirement age. Before we get into the different ways you could withdraw money, there are some more general things to think about first. Try asking yourself the following questions: How long will I need my money to last? How long do I want to keep working? How much tax might I pay? Could my health and lifestyle affect what I get? How much do I want to leave behind?
For independent, expert advice on retirement planning, pensions and other financial issues, please get in touch with the Farnham-based team at Fish Financial and we’ll be happy to help!
ACCESSING PENSION BENEFITS EARLY MAY IMPACT ON LEVELS OF RETIREMENT INCOME AND YOUR ENTITLEMENT TO CERTAIN MEANS TESTED BENEFITS AND IS NOT SUITABLE FOR EVERYONE. YOU SHOULD SEEK ADVICE TO UNDERSTAND YOUR OPTIONS AT RETIREMENT.
A PENSION 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.
PENSIONS ARE NOT NORMALLY ACCESSIBLE UNTIL AGE 55. YOUR PENSION INCOME COULD ALSO BE AFFECTED BY 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.
THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED.
PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.