Now that I don’t need to buy an annuity, how can I take money from my pension?
In the 2014 Budget George Obsornne declared, “no one will need to buy an annuity again” All of a sudden, retirees had more options for using their pension funds. With that increased freedom comes the need to make a well thought through decision.
In this post l explain the retirement income choices you have.
Let’s start with the annuity:
You can purchase an annuity using the pension fund built up during your working life. It’s a good option if your priority is to have a guaranteed income and you don’t want to take any investment risk. You must also accept that the fund value won’t be available to your estate or your spouse when you die.
You can take out up to 25% of your fund as cash, tax free. The remainder provides your income. Like buying a car you can add on various options: an income that rises over time, a spouse’s pension, or a guaranteed period so a premature death doesn’t reduce the total income. The more options you choose, the lower your starting income.
The younger you are the lower the annuity that will be paid. If you have a lower life expectancy your income may be higher. Always shop around to find the highest income available, no matter who your fund is invested with.
Remember too that annuity income is taxable, so could attract tax of up to 45% assuming you have no other income.
Being locked into an annuity for life may not seem the most attractive option. Let’s see what else you could do with your fund.
Any time after 55 you can take capital from your pension fund.
Uncrystallised Pension Fund Lump Sum allows you to take capital from your pension, in part, whenever you need it. If you take the whole fund at once, 25% would be tax free with the balance being taxed as income. This could be up to 60% if total income in the year is greater than £120,000. Probably not a good idea.
Or, you can withdraw income as and when you need it. Again, 25% will be tax free. The balance will be added to any other income received in that year and taxed accordingly. Again, potentially up to 60%.
Flexi-Access Drawdown can be a more tax efficient option. Instead of taking capital and having part of it taxed as income immediately, you can take the tax-free lump sum and defer taxable income payments. The residual fund remains invested in a separate pot known as drawdown.
The tax-free lump sum can be taken at once or in smaller installment until 25% of the fund is used up. Once it is used up any further income taken from the fund will be taxable.
With both Uncrystallised Pension Fund Lump Sum and Flexible Drawdown, the income taken can be changed year on year.
One of the most popular features of both these options is the ability to pass any remaining fund onto future generations, tax efficiently, on death.
The greatest danger with both options is that the combined effect of withdrawals and poor investment returns can result in the pension being eroded early – leaving insufficient wealth to fund your lifestyle.
You can, of course, purchase an annuity at any point if a guaranteed income becomes your priority.
There’s a lot to think about when taking income from your pension. Avoiding unnecessary tax and not eroding the fund is imperative so prudent management of pension income is vital.