If you’re due to retire this year, you’ve no doubt been preparing for your life milestone for some time. This preparation might have included a look at the flexible retirement options introduced in 2015 and known collectively as Pension Freedoms.

Pension Freedoms have been incredibly popular since their arrival, but what of the traditional option, drawing a regular pension?

Annuity rates have fallen over the last few years, a reaction to increased life expectancy and low interest rates.

The Guardian recently reported that a 65-year-old man buying a standard, level Annuity with a £10,000 pension pot in 1995, received a typical payout of £1,110 per year for the rest of his life. By September 2010 the amount would have been £606, falling to £468 a year by the start of 2019.

Are Annuities still a viable option in a market that offers the flexibility of Pension Freedoms?

The benefits of an Annuity:

  • It pays a regular, guaranteed income for life

Once an Annuity is set up and in payment, it will continue to pay for the rest of your life.

This makes budgeting in retirement easier. You have a regular known income to factor in and no decisions to make once the pension is in payment.

  • You can receive a tax-free cash lump sum

As well a regular income, you might also choose to receive a Pension Commencement Lump Sum (PCLS). This is a one-off, tax-free cash payment normally up to a maximum of 25% of your fund.

It comes directly from your pension pot and the Annuity is purchased from what remains. Taking a lower amount of tax-free cash would mean a higher annuity.

  • You might be able to opt for additional benefits

You need to specify your preferred pension basis at the outset. This includes the payment frequency and also any ‘extra’ benefits the scheme offers.

This might include a spouse’s pension, paid in the event of your death, and commonly paying 50% of the amount you received. This will affect the amount of annual pension you get but gives you peace of mind that a spouse or civil partner will be looked after in the event of your death.

You might also opt for an ‘escalating’ pension, one that increases each year by a set percentage to combat the effect of inflation.

Again, this will decrease the amount you receive initially but will make budgeting easier as your pension rises with the cost of living.

The disadvantages of an Annuity

  • An Annuity is inflexible

Once an Annuity is set up it can’t be altered and will continue to pay the agreed amount until you die. The whole pension pot is used up and there is nothing additional to pay, nor no way of accessing future payments early.

  • A lump sum is limited to 25%

If you’re looking to use retirement to renovate your house or travel the world, for example, you might be looking to access a large element of your pension pot in one go in order to fund it.

By taking all your fund as an Annuity you limit yourself to 25% of your pension pot as a lump sum.

Pension Freedoms

The flexible retirement options known as Pension Freedoms have been with us for over five years now.

As you’d expect, they provide greater flexibility than the standard Annuity option, but this greater flexibility places more responsibility on you to take control of your retirement fund and budget efficiently.

The main flexible options are:

  • A lump sum

An Uncrystallised Fund Pension Lump Sum (UFPLS) is a lump sum that can allow you to free up a large amount of cash in one go. Normally, 25% of this payment will be tax-free, with the rest taxed as income at your marginal rate.

You might be able to take multiple UFPLS payments, each taxed the same way, though this may depend on your provider.

Unlike an Annuity, an UFPLS frees your entire pot in one go, giving you access to a large amount of cash that could be used to fund travel or to help a child onto the property ladder.

It is inflexible though once you take a lump sum you extinguish all rights within the scheme, and there are no further monies to be paid. Care should be taken that a large one-off payment could push you into a higher tax bracket.

You have full responsibility for ensuring the lump sum amount lasts for the duration of your retirement.

You should also be aware that an UFPLS will trigger the Money Purchase Annual Allowance, reducing your annual allowance – the amount you can pay into a DC pension and still receive tax relief – to £4000.

  • Flexi-Access Drawdown

Using drawdown, you can take tax-free cash, up to your entitlement of 25%, but then leave the rest of your pot invested so that you can ‘drawdown’ an income from it when you need it.

Unlike an Annuity, the frequency and amount of each payment is chosen by you, giving you full control.

Greater flexibility can make budgeting harder and the emphasis is on you to ensure your remaining pot will allow you to maintain your desired lifestyle for the duration of your retirement.

Taking drawdown also triggers the Money Purchase Annual Allowance (MPAA), reducing your allowance to £4,000.

If you’re considering this option but intend to keep making pension contributions, you’ll need to be aware of this reduced allowance.

A combination that suits you

You might choose to take a combination of flexible options, but it might also be possible to combine flexibility with the traditional Annuity option.

Consider, for example, using a traditional Annuity to pay for your fixed expenses such as bills and your mortgage, whilst accessing additional funds flexibly to pay for any discretionary, additional expenses.

Remember that once an Annuity is set up and paying you a regular income it can’t be cancelled or changed. Once you’ve taken a full UFPLS, that pension pot is also extinguished, and the amount received is yours to manage.

If you’re unsure about any of the above pension options, or the combinations available, speak to us. Please email info@investmentsense.co.uk or call 0115 933 8433.

Please note:

A pension is a long-term investment not normally accessible until 55. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Your pension income could also be affected 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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