Your retirement – spoiled for choice?
First published 14 January 2015 • Updated 13 March 2018
The way we fund our retirement is changing beyond recognition, with many of the new reforms coming into effect from 6th April this year. But the increased range of choice perhaps creates the potential for confusion and an even greater need for professional advice. Armstrong Watson Financial Planning gives us a simple summary of the basic options now available.
George Osborne’s pension reforms mean that people now have almost total freedom in how they can access their pension savings when they retire. There is no longer a requirement to buy an annuity (although many may still prefer to do so) and there are many more available options for funding one’s lifestyle in retirement. But all this choice can be bewildering, and any decision you make now can affect your standard of living for the rest of your life. In other words, proceed with caution.
First of all, it is helpful to see the major alternatives clearly laid out.
Pension options on the table
Having full access to your pension fund is one of the new possibilities. You could use this option to clear debts, go on the holiday of a lifetime, or buy a nice car for example. For some people the urge to treat themselves may prove very hard to resist – so hard that they forget the fundamental purpose of their pension fund, which is to provide them with a living income in retirement. A hasty decision to access the fund and go on a spending spree could compromise their lifestyle for years afterwards.
There is tax to consider too. Generally speaking, only 25 per cent of the total fund can be accessed tax free, so anything in excess of this would be subject to income tax at the individual’s highest rate. In some instances this could result in a tax charge of up to 45%.
A more measured alternative to this is to set up a new drawdown arrangement. This is where the fund remains invested, but allows an income to be withdrawn with no restrictions or caps. This can help you manage your income tax position, because the whole fund isn’t being taken as one lump sum. By taking professional advice and planning carefully, you should be able to stay below the higher rate tax threshold, while still being entitled to receive up to 25 per cent of the fund tax free, with income withdrawals taxed as income at your marginal rate.
This option has a risk factor too: since the fund remains invested, it can still fall as well as rise. Furthermore, the income drawdown will deplete the fund, so if your withdrawals exceed the investment growth then the overall fund value will diminish (and so growth will decrease too). Because of these complexities, it is vitally important that you review your arrangements regularly to make sure that the fund doesn’t run out, leaving you with a drastically reduced or even non-existent income from it.
The long-established option of the annuity is still a viable one. As well as being no longer compulsory, annuity purchase is also more flexible thanks to the new rules. Unlike drawdown, annuities do not retain an investment element, so purchasers need not worry about market risk – the income is guaranteed for life. The problem with annuities is that the level of income you receive will be based upon prevailing annuity rates, which are still at historically low levels. Also, this income is taxable at your marginal rate of income tax, though you can still receive up to 25 per cent of your pension fund tax free.
If you choose not to buy an annuity, then you will still need to consider crucial factors such as your health and how long you are likely to live. Today, a typical 65 year old in average health can expect to live another 20 years or more. This means you must plan carefully to ensure that your money does not run out. If you happen to be taking early retirement, then you also need to consider how adequate your income will be in the years before the state pension kicks in.
Finally, if you have any pension plans that are valued under £10,000, then you have the option to withdraw the whole fund as a lump sum, 25 per cent of which is tax free, with the balance taxed as income at your marginal rate. This option does not restrict further pension savings, so means that up to £40,000 per annum can be saved into a pension. However, if you still wish to pay into a pension utilising any of the options mentioned here, this will then restrict your annual contribution limit to just £10,000.
Broadly speaking, these are the potential routes open to you – and it is of course possible to select a combination of them. Given the number of choices now available for those seeking to secure retirement benefits, it is clear that professional financial advice is key to making the right decision for most people.
Find your local financial adviser today at unbiased.co.uk.
About the author
Armstrong Watson is a firm of Chartered Accountants, Financial Planners and Wealth Managers.