The wonderful, over-complicated world of pensions is full of jargon, so let’s start with a jargon-buster:
Annuity: An annuity allows you to swap your pension savings for a guaranteed regular income that will last for the rest of your life.
Flexi-access drawdown: Flexi-access drawdown is a pension product that lets you access your pension savings whenever you need to, while reinvesting your remaining funds.
Defined contribution (DC) pension: a pension pot based on how much is paid in.
Defined benefit (DB) pension: A defined benefit pension (also called a ‘final salary’ pension) is a type of workplace pension that pays you a retirement income based on your salary, number of years you’ve worked for the employer & other factors, rather than the amount of money you’ve contributed to the pension.
Pension Freedoms legislation: Introduced in 2015, the Pension Freedoms legislation enabled consumers to flexibly access their DC pension pots from the age of 55 and use the funds for a wider range of options including cash withdrawal, retirement income products, or a combination of the 2
Tax-free cash: The amount that can be withdrawn from a DC pension and not assesses for income tax. the official term for tax free cash is a pension commencement lump sum (PCLS) and is normally 25% of the pot.
Important points before we start:
- The options below relate to Defined Contribution pensions (see jargon buster). A very common type of pension. You put money in, you get tax relief on top and, if you’re employed, your employer contributes too. You then have several options, normally from age 55
- You don’t HAVE to access your pension. A common misconception is a pension ‘matures’ at 55, 60 or 65 for example.
- A word of warning – Many older pensions have special features such guarantees, early pension age or more tax-free cash. Please think about getting advice before proceeding.
Some of you might have a Defined Benefit pension, especially NHS employees, teachers and other public service workers. Hugely valuable, but we’ll save this for another blog.
So… what are you options from age 55…..
- Do nothing
You don’t have to access your pension pot. In fact, most people leave their pension pots until their mid-60’s. Even though you will have a ‘normal retirement date’ on your scheme and although your pension provider will send a letter with big bold letters like ‘It’s time to make a decision about your pension’, you don’t need to do anything. However, you may want to access funds for various reasons, so….read on….
- Get yourself a guaranteed income for life
This is called an annuity. You could buy your own guaranteed income in the form of an annuity. There are loads of options with annuities, so it’s worth getting yourself some quotes and advice if you’re considering this route. The annuity you could receive will depend on many factors including your health/lifestyle, your age, the size of your pension pot and current annuity rates.
Annuities have become less popular in recent years.
- Flexible-Access Drawdown
Introduced in 2015 under the Pension Freedoms legislation, you can now opt for Flexi-access drawdown. This is the most popular option and the clue is in the title – it’s flexible.
You must be careful not to run out of money though…
- A mixture of 2 & 3
You could mix & match. For example, you could buy an annuity to top up your state pension and help cover your main bills, then use Flexi-access drawdown for your additional spending and extra luxuries.
- Take the whole pot
This is a popular option for smaller pots, where an annuity would provide a negligible income and Flexi-access drawdown either isn’t available or not required. 25% would normally be tax-free and the remainder is counted as regular income, so beware of large tax charges if you’re taking a big pot.
- Take small lump sums
Like Flexi-access drawdown, you could leave the pot invested and draw small lump sums occasionally. Each withdrawal would be 25% tax-free and the remainder counts as income, so could be taxed.
Annuities might not be popular, especially with the introduction of Flexi-Access Drawdown, but they are an important conversation and option. Don’t forget, with Flexi-Access Drawdown you’ll need to make sure your money doesn’t run out. When it’s gone, it’s gone.
Flexi-access drawdown has some great benefits, but don’t underestimate your life expectancy. If only we could know the date of our demise, we could time if perfectly…
Everybody’s circumstances & needs are different, so each option could fit someone. Many people access a small amount early to settle a mortgage, holidays, home improvements and leave the remaining funds to grow. Whatever you do, make sure you do your research or get independent financial advice.