If you’re close to your anticipated retirement date or State Pension Age (SPA), your thoughts will be dominated by how to turn your pension pot into an income.
Questions such as, is Annuity or Income Drawdown right for me? Would another option be better? How can I get the best Annuity rate will rightly dominate your thoughts.
But, there is one option which is all too often overlooked:
Deferral.
In other words waiting to take your pension and leaving it invested.
Not taking your pension sounds like a crazy idea, but bear with us, there are many very good reason why some people should consider it as an option.
When could deferment be useful to you?
There are a number of occasions where a delay in taking your pension could benefit you and your family:
If you don’t need the income We spoke to a chap recently who had reached 65, the retirement age on his pension plan and was thinking of buying an Annuity. The gentleman had not retired; in fact he had no intention of retiring soon and didn’t need the income, so why did he want to buy an Annuity?
Simply because his pension provider had written to him telling him is nominated retirement age had been reached and a ‘non-advised’ Annuity broker was trying to sell him an Annuity!
By buying an Annuity he would have:
- Created income, which he didn’t need and increased his tax bill
- Lost the ‘free life cover’ provided by the pension (if he dies before the age of 75 the whole of the pension fund will pay out as a tax-free lump sum)
- Lost the chance to get a better Annuity rate when he is older, in worse health or if rates were to rise (which is obviously not guaranteed)
- Lost the potential for future tax-efficient growth on his pension fund (again, this is of course not guaranteed)
- Moved his 25% tax-free lump sum from a tax-efficient environment into a taxed savings account; he didn’t even need the tax-free lump sum so would have just put this into a deposit account
We advised this gentleman against buying an Annuity, or indeed using any other retirement income option. But, we did recommend that he review his existing pension to ensure that the charges he was paying were competitive and the investments he held were performing well and were suitable given his age and attitude to risk.
If you have enough income from other sources If you have sufficient income from other sources, deferring the decision to turn your pension pot into an income can have significant advantages, particularly in terms of leaving your dependents a tax-free lump sum on your death.
If your pension pot has fallen in value Whilst the world’s stock markets have been reasonably stable over the past year or so, there have been times when this was not the case. Converting your pension pot into an income, particularly if you are buying an Annuity just after a stock market fall, will mean you have less income every year, for the rest of your life. In these circumstances deferral can give you pension pot time to recover.
If you think Annuity rates will improve Due to a range of factors Annuity rates are low compared to historical levels. If you think Annuity rates are going to rise in the future, or you will qualify for an Enhanced Annuity due to worsening health, it may pay to defer your purchase until a later date. Of course, there is no guarantee Annuity rates will rise, indeed they could fall further.
If you can’t decide which is the right option for you Buying an Annuity is a decision which can never be changed. Unlike almost every other large purchase you will ever make, once your income has started, you can make no changes whatsoever. If you are unsure which retirement income option is right for you, or can’t make your mind up which options you should add to your Annuity, deferring a decision until you are sure you are doing the right thing could be a viable option. Remember though, if you are deferring for a short period you should take steps to ensure your pension pot is protected from falls in the stock market; this is relatively easy to do.
If you are seriously ill If you die before 75 and before you have turned your pension into an income, the whole pot will be available as a tax-free lump sum, for your family or financial dependents to enjoy. Compare that to an Annuity where the options on death are far more limited, or Income Drawdown, where any lump sum after death is subject to 55% tax.
What do other financial experts think?
We asked Annie Shaw (right) of the Daily Express for her thoughts:
“As with all investment decisions, deciding whether to delay taking an income from your pension will depend on your personal circumstances and your attitude to risk – and is a decision best come to with help from a qualified adviser.
The received view of many advisers who have clients who can afford to defer “decumulation” of their fund is generally to do so. This may be based on one or more reasons including: avoiding subjecting the withdrawals to higher rate tax (particularly if the client is still working); allowing the fund to grow further over time and the hope of a better Annuity rate as time passes.
All these may be valid reasons in their own particular contexts. But where there are no obvious advantages to delaying taking an income, such as a switch to a lower tax band once employment ceases, the other reasons start to look rather feeble.
There is no guarantee that Annuity rates will rise, either because of a change in the gilt yield or because of the intending annuitant’s age.
Any uplift that is achieved always has to be offset against the loss of income during the years during which deferment has taken place. Nor is the fund likely to grow much if it is “lifestyled” – switched into fixed income or other safe havens – in the years prior to the original planned retirement date. That leaves the client looking for a better Annuity further down the line with the “hope” of developing a serious medical condition in order to qualify for an enhanced annuity. Not really a lot to look forward to.
So what if you don’t “need” a retirement income on the appointed date? The cautious investor could, alternatively, consider taking their Annuity as soon as possible and deferring the state pension, where the annual uplift for deferment is at least guaranteed.
Of course the decisions of wealthier clients may be skewed by different reasoning. The better-off may be prepared to take more risks with their cash prior to retirement if they have alternative sources of funds should the worst come to the worst, enabling them to seek more growth from their fund. Indeed, their priority may be to delay annuitisation as long as possible and perhaps indefinitely, to use Income Drawdown to obtain an income rather than taking an Annuity – or a combination of the two – and even to aim to leave some of the fund to loved ones when they die.
Middle of the road customers will however need to assess their priorities. Is their aim to ensure their retirement income is secure; or to maximise income by taking some risk; to avoid tax; or to attempt to preserve their fund for the benefit of others?
I suspect that for all but the wealthiest, ensuring their retirement income is secure is going to come top of the list. Once that decision is taken then for most of these people deferment will either not be an option because they need the money to live off or will be pointless.”
Do you need help deciding which retirement income option is right for you?
Our team of Independent Financial Advisers are experienced in developing retirement income strategies for clients the length and breadth of the UK.
If you are approaching retirement and would like advice on all of your options, including deferral, call one of our IFAs today on 0115 933 8433.
Alternatively enquire online or email info@investmentsense.co.uk
