Since 2015, retirees have had far more choice in how and when they access their pension savings. In the past, it was the norm to purchase an Annuity to secure a guaranteed income for life. However, retirement lifestyles and aspirations have changed enormously over the last couple of decades and, as a result, many are favouring a more flexible approach to income.
A guaranteed income
If you have a Defined Contribution pension, the only way to create a guaranteed income throughout retirement is to purchase a financial product known as an Annuity. This used to be the default option for many retirees, but things have changed over the last few years.
Should you decide you prefer the security of a guaranteed income, you take your savings out of your pension and purchase an Annuity, which will pay out a predefined amount each month for the rest of your life. Depending on the type of Annuity you purchase the income may be linked to inflation, maintaining your spending power through retirement. You may incur Income Tax on the income received through an Annuity.
A flexible income
Since 2015, withdrawing an income flexibly from a pension has been an option and one that’s proven popular with many retirees. Usually, this is done through Flexi-Access Drawdown. Your pension savings remain invested, to hopefully keep pace with inflation and grow, and you choose when and how much is withdrawn. As the name suggests, you can change this to suit differing needs. However, you will be responsible for ensuring the savings last through retirement and investment risk.
You can also choose to withdraw money from a pension in lump sums. However, while up to 25% can typically be withdrawn initially tax-free, Income Tax will apply to withdrawals above this amount which may push you into a higher tax bracket and it’s not usually the most tax-efficient option.
Deciding which option is right for you
There’s no right answer for which type of retirement income is best, it depends on your personal circumstances and what you want to achieve in retirement. Among the questions to consider to help you understand how the options suit you are:
- What is your life expectancy? One of the crucial elements of building a retirement income is understanding how long provisions will need to last for. This allows you to put the income an Annuity would provide into perspective, as well as calculating how money in Flexi-Access Drawdown would have to perform over your lifetime to deliver the same level of income.
- How do you feel about investment risk? A flexible income may give you an opportunity to increase your pension, but it does come with a level of risk. Are you comfortable with the value of your pension falling in the short term? Historically, investments have recovered when you take a long-term view, but some retirees prefer to be certain about the value of their pension over the potential to increase it.
- Are you comfortable managing your own finances? Choosing a guaranteed income allows you to take more of a hands-off approach when it comes to managing your finances, you’ll know exactly what you’ll receive and when. In contrast, with a flexible income, you’ll need to take a more active role, such as checking how investments have performed and deciding what a sustainable withdrawal level is.
- Which income matches your desired lifestyle? It’s time to think about the retirement lifestyle you want and how this will relate to spending. If you think your expenditure will experience peaks and troughs throughout retirement, for example, a flexible income can allow you to accommodate this. This is why it’s important to think about your finances in the context of your wider retirement plans.
- What other assets do you have? A pension is often the foundation of a retirement income, but it’s usually supported by other sources of income. Depending on your assets, you may be able to use these to create a flexible income when it suits, whilst using your pension to provide a reliable source of income for the rest of your life.
One key thing to note here is that you don’t have to choose between a guaranteed and flexible income. Pension Freedoms mean you can take advantage of both options. For example, you may choose to use a portion of your pension to purchase an Annuity, providing you with certainty that essentials will always be covered. The remainder than can then be accessed flexibly to suit your needs at the time. It’s an approach that can help you create a retirement income that’s tailored to you.
Understanding the long-term impact of your decision
Deciding how to take an income from your pension is an important decision; it’s one that may affect the rest of your life. It can make the decision process daunting and you may find it difficult to fully understand how it’ll impact your life in 20 or 30 years. Financial planning can help you see what the right decision is for you now and over the course of retirement. If you’re unsure about how you should be taking an income from your pension, please contact us.
Please note: 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. 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.