When it comes to taking money from a pension most people just take the tax free lump sum and then buy a Lifetime Annuity, but there are so many other options available.
We can think of 10, how many can you name?
We thought we would take ‘whistle stop tour’ of all the options available to you, some you will know, some you may have forgotten and others you might not even know exist!
Before we start please be aware that the guide is not intended for those people in defined benefits (final salary) pensions.
1. Lump sum or no lump sum?
A proportion of your pension, usually up to 25%, can be taken as tax free cash or Pension Commencement Lump SUM (PCLS) to give its official name.
You must decide at outset whether to take the tax free lump sum from your pension, with the exception of Phased Drawdown, once you have entered a retirement product, the option to take the tax free lump sum is lost.
2. Lifetime Annuity
This is the most common method of creating an income, in simple terms your pension fund is handed over to an Annuity provider and they guarantee to give you an income for the rest of your life.
Various options can be added, for example you could include a spouse’s pension to ensure that the income would continue to your husband or wife should you die before them. You can also include indexation, so that your income increases each year in an effort to combat the effects of inflation.
Using a simple online pension Annuity calculator will give you a guide as to what level of income a Lifetime Annuity will give you.
Lifetime Annuities are probably the simplest way of taking income from your pension and tend to be used by people who want no investment risk and require a guaranteed income for the rest of their lives.
3. Enhanced Annuity
These work in exactly the same way as a Lifetime Annuity but take into account any health or lifestyle issues you may have which could possibly reduce your life expectancy, therefore increasing the income that is payable from the Annuity.
4. Fixed Term Annuity
The current crop of Fixed Term Annuity products are relatively new. They provide an income for a set period of time, typically for between three and 10 years, after which time you receive a Guaranteed Maturity Amount (GMA) which can be used to buy an alternative retirement product or indeed another Fixed Term Annuity.
Fixed Term Annuities tend to be used by people who do not want to buy a Lifetime Annuity at the current time, perhaps because they hope Annuity rates will rise in the future or they will qualify for an Enhanced Annuity in years to come.
Fixed Term Annuities can also be used by people who want to access their tax free lump sum, but do not want to take an income at the same time.
5. Investment Linked Annuity
This offers the same options as a Lifetime Annuity, spouse’s pension, guarantee periods and so on but in contrast the income is not guaranteed and is dependent upon the underlying investment performance of either the Unit Linked or With Profit fund you are invested in.
At outset you choose a level of income and an anticipated rate of return, each year this is compared to the actual return. If the actual return has been higher than the anticipated return your income will rise, if it has been lower your income will fall.
Investment Linked Annuities are used by people who want to try and receive a rising level of income in years to come and who are prepared to take some investment risk to achieve this.
6. Income Drawdown: Capped Drawdown
Income Drawdown allows you to take income, subject to certain limits, directly from the pension fund which remains invested.
When you enter Capped Drawdown a calculation is done showing the maximum level of income available, you can then decide how much income is taken up to this level. The maximum level of income available is based on your age, gender and gilt rates. If you are under 75 this calculation is redone every three years, if you are over 75 it is done annually.
You can alter the level of income you take each year, although you can never take more than the maximum permitted level, unless of course you qualify for Flexible Drawdown, more of which in a moment.
Income Drawdown is used by people for a number of reasons. Firstly it can provide a flexible income, which can be valuable to some people. Secondly it can allow the tax free lump sum to be taken without the need to take an income. Thirdly Income Drawdown can offer a wider range of options on death, which can include an ongoing income or indeed a lump sum.
Income Drawdown carries significantly more risk than a Lifetime Annuity as the money remains invested; it also requires an ongoing commitment to review the investment on an ongoing basis.
7. Income Drawdown: Flexible Drawdown
Flexible Drawdown allows you to take a higher level of income from your pension fund than you can from Capped Drawdown, to do this you must satisfy the Minimum Income Requirement (MIR).
To meet the MIR you must have a guaranteed income of at least £20,000 per year from pensions already in payment. Broadly speaking income from defined benefit (final salary) pensions, the state pension and Annuities (although not Purchased Life Annuities) count towards the MIR.
Once you have satisfied the MIR you are free to take as much income as you like from your pension fund, with no upper limit, as there is with Capped Drawdown. Income is still taxed at your highest marginal rate.
Flexible Drawdown was only introduced in 2011, it is therefore hard to say exactly who will use it, although we can speculate that it will be useful for those who already have a substantial level of guaranteed income and may in some years want to top this up with additional amounts of income over and above that which would normally be available from Capped Drawdown.
8. Scheme Pension
Like Drawdown the income is taken directly from the pension fund. Whilst you therefore retain control of the investments the risk sits with you.
The maximum level of income available is calculated by the scheme actuary and is based on your age, gender, health and the value of your fund. Once the maximum level of income has been calculated you as the member can decide what level of income you wish to receive. You can also include a guarantee, so that if you do sooner than is anticipated, your estate continues to receive the income for a period of time.
The level of income is recalculated every three years, which may see the maximum which can be taken rise or fall, depending on the performance of the fund.
Whilst not new Scheme Pension has been reinvigorated following recent changes to legislation and product development by certain pension providers. It is hard to say exactly who will use it, certainly you need to accept investment risk, however, because your state of health is taken into account it may well provide, at least for a time, greater levels of income than are available from Capped Drawdown.
9. Phased Drawdown
If you do not need the tax free lump sum then it can be used to provide ‘income’ in a tax-efficient way. A proportion of the fund can be crystallised with the tax free lump sum and the associated drawdown fund used to provide income to a targeted level. Each year this process is repeated until such time as the maximum tax free lump sum, i.e. 25% of the total fund, has been taken, after which point income is simply the normal amount available under Capped Drawdown rules.
Phased Drawdown carries investment risk, as the fund remains invested, however it is a useful way of providing a tax-efficient income for those people who do not require the lump sum of capital at retirement.
If the value of your pensions are below a certain limited, £18,000 in the 2011/12 tax year, you can access the entire fund as a lump sum and do not need to use a retirement income product. The first 25% of the fund is paid tax free; the balance is added to your income in the year which you take it and is subject to income tax.
To access your pension fund under the triviality rules you must be at least 60 years of age, there is no longer an upper limit.
So, how many did you get?
Well done if you got all 10, in fact, why not call us? We might want to hire you!
On a more serious note, the fact that there are at least 10 ways of taking an income just highlights the importance of assessing all the options when the time comes to retire, some are relatively straightforward with no investment risk, others are significantly more complex, all though require careful thought to make sure you are making the right decision.
Our team of Independent Financial Advisers are of course here to help you make the right decision, if you are coming up to retirement, or indeed currently have one of these retirement products, and would like advice do not hesitate to call us on 0115 933 8433 or email email@example.com