Tony Granger highlights some tips and possible traps when deciding what to do with your pension pot.
Around 800,000 people retire every year, some financially very poorly, mostly because they do not know what their options are. You can take an annuity or enter drawdown from age 55. If in drawdown, you can elect to take an annuity from your pension funds at any time. Annuity rates have been at a 300-year low, which is why many opt for the fund to continue to grow and to provide an income (drawdown), rather than be locked into a low level of income for life (annuity).
Annuities
An annuity pays an income for life. The more guarantees you wish the annuity to have, the less income it provides. For example, a single life annuity with no guarantees will pay the highest income. If you elect for the annuity to pay out for your lifetime and then for the lifetime of a spouse or civil partner, with inflation escalation, this is the most costly annuity with these guarantees costing up to 70% of the value of your pension fund.
If a smoker or in ill-health (cancer, high blood pressure etc.), then you can be medically underwritten (as can your spouse for a survivor annuity) to try and obtain a higher enhanced annuity rate. The annuity is taxed at your marginal rate. Once taken, it can never be changed.
Some tips:
(i) Be medically examined before you decide on options.
(ii) Check policies – there may be guaranteed high annuity rates – some in excess of 10% p.a. written into the policy.
(iii) Check all annuity options, growth annuities are available.
(iv) Always shop around for the best rate – on average you will be 11% better off.
Income drawdown
Drawdown is the ability to take a pension income from your pension fund which is flexible, and which accords to your needs. The minimum ‘pension pot’ is from £50,000.
Income is drawn down from your pension fund while the fund remains invested and continues to benefit from investment growth. You can draw this income indefinitely – there is no need to take tax-free cash or an annuity from age 75 (the previous rule). There is no minimum amount of income to be drawn, irrespective of age. The maximum amount of income to be drawn down is 120% of the single life annuity that a person of the same age could purchase based on GAD rates. The maximum income is reviewed every 3 years until age 75 and annually from age 75.
There are two types of income drawdown available:
- Capped drawdown: select an income at between 0% and 120% of the GAD limit. Your fund continues to grow and you can make further contributions to it. Income is taxed at your marginal rate.
- Flexible drawdown: If you meet a minimum income requirement (MIR) of £20,000 from other pension sources, you can draw down income or cash lump sums without restriction. After accounting for 25% tax free cash, lump sums and income drawdown are taxed at your marginal rate. Once selected, no further contributions can be made to the fund in the current tax year.
Drawdown can be risky, depending on how your funds are invested. However, it is also very flexible.
Further tips
(i) Consider investments for growth.
(ii) Do not take out more income than the growth of your funds.
(iii) You can take an annuity at any time. For example, your health may have declined or you may not have dependants to leave funds to.
Practical Tip:
In the final analysis, there are no right or wrong answers, and much depends on the size of your fund, your state of health, your attitude to risk, and the amount of income you need - and for how long. Most will opt for drawdown, and take an annuity should circumstances warrant it, later. As always, professional advice based on your specific circumstances is important.
