What will you do with your pension?
Taking the cash
Until the new rules came into force in April 2015, only those with very small pensions could cash them in. Now, from the age of 55 any saver with a defined contribution scheme can take the lot. You can do as you wish with your money, whether that means blowing it on a sports car, making an investment, purchasing a property or starting a business. However, the catch is that only the first 25% is paid tax-free. The remainder will be taxed at your marginal rate. The taxman will also consider your withdrawal as income for that year, which could bump you into a higher bracket
Still, it may make sense taking some (or all) of your pension if you have an urgent need for the money - debts to repay for example - or your pension is so small that it is not enough to generate a meaningful income. However, even in these instances if your withdrawal will move you into a higher tax bracket, it may make sense to phase your withdrawal across a number of tax years to reduce your bill.
Aside from the income tax you would need to pay in the short term, you also need to consider the tax benefits you give up when you take your money out of a pension - namely tax-free growth and protection from inheritance tax.
Lots of people want to have more control over their pension and invest their money, but you don't have to take your money out of its pension "wrapper" to do this. It's much more tax-efficient to move your money into income drawdown. Not only will you be spared a potentially huge income tax bill, you will also continue to enjoy tax-free growth on your savings and keep money out of your estate for inheritance tax (IHT) purposes.
Your existing pension provider may offer a drawdown service, or you can transfer your holdings into a more modern self-invested personal pension (Sipp). Once your money is in income drawdown you can take as much or little money out of your plan as you choose - this might mean taking a monthly income or only making withdrawals for ad hoc expenses if you have other sources of income.
But while you might love the idea of flexibility and control, income drawdown is not without risk. This is because your money remains invested and your income is not guaranteed - together these two factors mean there is a chance your savings won't last as long as you do.
You can run your investment portfolio yourself. However, the risks mean it's only recommended for those with experience of buying and selling investments as well as the time and commitment required to manage them. Less experienced or less enthusiastic investors may find it's worth paying for independent advice.
Buying an annuity
Annuities have long had a bad press. Pension providers have been accused of failing to let customers know they can shop around for a better deal, while increasing life expectancy and low interest rates mean the income they pay has plummeted.
Despite these problems, they offer something income drawdown cannot and that's guaranteed income. Even if it's less than you'd hoped - it will carry on being paid, however long you live. Shopping around and taking care to consider how any dependants will be looked after once you die will help you get a good deal. If you have any health problems (you don't necessarily have to be ill) or lifestyle issues (for example, you smoke or are overweight) you may also qualify for enhanced rates.
Lifetime annuities pay you a guaranteed income for life. You can purchase plans that pay a lower income initially but that increases in line with inflation but these are widely regarded as expensive and most people go for plans that pay a level income over the term.
Another option is investment-linked annuities. Here your money is invested and assuming stockmarket returns are in your favour your income should rise over the years. However, if returns aren't so good your income will fall. Minimum income guarantees prevent it falling below a set limit. That said, these risks mean they aren't usually recommended for people with smaller pots or those who cannot afford to see their income drop.
With any annuity, payments stop when you die and any remaining funds go back to the insurer. But it is possible to protect your money. If you are married or have a partner you can opt for a joint-life plan where payments continue for your other half. You can also guarantee payments for a fixed period (up to 30 years from 10 following the reforms). Alternatively, you can plump for value protection, which returns unspent capital.
These elements all provide peace of mind, particularly if you have family that is dependent on you. The catch, of course, is that they come at a price and reduce the level of income you receive.
Mix and match
You don't just need to select one option, nor do you need to rush into making a decision. Advisers are predicting many retirees will adopt a "mix and match" approach - using a variety of strategies to provide income and access to lump sums when required.
For example, you might use some of your pension to buy an annuity to ensure you have enough to cover your bills and then leave the rest invested to provide a financial cushion and protection from inflation. Alternatively, you might start off with money in drawdown and then purchase an annuity later on. The advantage of this strategy is that in buying your annuity later you'll get a higher income - especially if your health has deteriorated.
Likewise, if you can, it may be sensible to spend other savings first. While you will undoubtedly regard your pension as your retirement savings, the tax benefits are so good it may be worth leaving it untouched for as long as you can.
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The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.