Most people who retire still take the tax free lump sum from their pension, indeed recent research from the Prudential showed that nearly 80% of people retiring last year took the lump sum from the company scheme or personal pension plan.
Historically pension savers have put their tax free lump sum to a variety of uses, indeed many saw it as something of a bonus, perhaps to pay for a lavish holiday to celebrate retirement, change the car, repay debt or simply put the money to one side as a nest egg.
Research, again done by the Prudential, shows that a third of people last year spent their lump sum on home improvements whilst another third went on holiday with the money, 20% of people bought a new car.
Annuity Rates
Annuity rates have fallen significantly over recent years, in the main this can be attributed to increased life expectancy and a reduction in gilt rates.
Lower Annuity rates may cause people to change their buying habits in the future; it is possible less people will see the tax free lump sum as a bonus and have to rely on it to ensure that they have sufficient income in retirement.
So, with falling Annuity rates, rising inflation, and historically low interest rates what are the main things you should think about when you are deciding whether or not to take a tax free lump sum from your pension:
What are your priorities, income or capital? Think about whether income or capital is more important to you. This really is the most fundamental question you need to answer when deciding whether or not to take your take free lump sum.
If you need capital, are there other options? Capital could be needed for all sorts of things and it can be tempting to see the tax free lump sum as an easy solution, but take a step back.
Take time though to look at other options, could you use existing savings to meet your capital requirements and use your pension to provider a greater income?
In the current climate it is unlikely that your savings will be attracting a ‘real rate of return’ i.e. above inflation, consider whether these should be used instead of the tax free lump sum from the pension.
Of course if your other savings are insufficient to meet your capital needs you may have to use some or all of your tax free lump sum.
If you need income consider all the options If income is a greater priority for you think about how best you can maximise your income.
Many people will simply use their entire fund to buy an Annuity, if you are thinking of doing this then consider the benefits of combining a traditional Lifetime Annuity with a Purchase Life Annuity (PLA).
A PLA benefits from preferential tax treatment as part of the income is deemed to be a return of capital. This can often mean that the net income of a Lifetime Annuity and PLA combination is better than using your entire pension fund to buy a Lifetime Annuity.
The exact benefits of a PLA vary according to your own personal circumstances but for both basic and higher rate taxpayers they are certainly worth considering.
Another popular alternative, is to invest the tax free lump sum in ISAs or a similar investment and then take an income. This route has been popular in the past as it preserves access to the capital, which is not the case if 100% of the fund is used to buy an Annuity. However it may increase the risk being taken if anything other than a Cash ISA is used.
Sufficient income and no need for capital Some people are in the fortunate position of having sufficient income for their needs whilst having no need for additional capital.
Despite being in this fortunate position care is still needed to make the right decision.
Should the lump sum be taken and invested? Would using it to buy a Purchased Life Annuity be advantageous? Could the lump sum be put to some other use?
These are just some of the questions which people in this fortunate position may wish to ask themselves.
No going back Whatever you decide about your tax free lump sum, think long and hard because whatever decision you make cannot be changed. Once you have bought an Annuity it cannot be changed and once you have taken the tax free lump sum there are rules preventing it being recycled into a pension.
Conclusion
There is no one size fits all approach to retirement planning; each set of circumstances requires an individual solution.
Independent financial advice can help you consider all the options fully to make sure that you get the important decisions right. Our team of Independent Financial Advisers are here to help you, they can be contacted on 0115 933 8433 or by emailing info@investmentsense.co.uk
Even if you decide to take independent financial advice do some research beforehand, read up on the main options you have available, use a pension annuity calculator to look at sample figures, think about what is really important to you.
