• Dylan Roberts

A short guide to taking pension income at retirement

This is the second in a short series of blog posts this week which will explore the often confusing world of pensions in a bit more depth.





In this post, we will explore the different options that are typically available to you when you reach retirement and begin accessing your pension benefits. If you would like to understand the options available before you reach retirement, you can read this post instead.


Before we go any further, you should note that not every pension will offer every one of these options. While you should be able to access every option, you may need to move your pension elsewhere to a pension arrangement that facilities your chosen option.


You should also note that this blog post is generic, and does not constitute financial, investment, or pension advice, which is always specific to individual needs and circumstances.


There are various different options for accessing your money at retirement, and there is no ‘one size fits all’. It is important to pick the option that suits your needs and circumstances, and the risks you are willing and able to take with your money.


You should also consider any guarantees you may already have with your existing pension arrangements, such as any guaranteed income provided by a Defined Benefit scheme or a Guaranteed Annuity Rate. Such guarantees are valuable and should not be given away lightly.


With that out of the way, what are your options at retirement?



Buy Guaranteed Income (by purchasing an annuity policy)


An annuity is an insurance policy. In simple terms, you exchange a lump sum of money for a guaranteed income. As this option provides guaranteed income, this means any investment risk is removed, so you can plan for your future secure in the knowledge of what your income will be and that you will not run out of money during your lifetime.


You can either purchase an annuity with your existing pension provider, if your provider offers this option, or you can purchase an annuity elsewhere on the open market – you should always check the best rates available.


The amount of annual income you will receive for the money you pay, which is called the Annuity Rate, depends on your own health and lifestyle, your family history of life expectancy, general and demographic trends such as overall life expectancy, and a range of other factors.


Advantages


  • Guaranteed income for life

  • No investment risk

  • So no risk of running out of money during your lifetime

  • Can be indexed to keep pace with inflation

  • Flexible Annuities do allow some flexibility in the income taken

  • A lump sum, typically of 25% of the pension pot, can be taken tax free

  • Flexible death benefits, meaning you can choose who to leave your money to

  • Death benefits tax free in the event you die before age 75

  • Easy to understand


Disadvantages


  • Income is generally fixed, which means you may take more income than you need to

  • Which also means you may pay more tax than you need to

  • As your money is no longer invested, it cannot achieve any growth

  • The annuity provider will apply a charge, deducted from your pension pot, at the outset, and will take an ongoing charge each year

  • Annuity rates are lower than historically

  • While death benefits can be passed on to a dependent or nominee, there is no further scope to pass benefits on through the generations.



Take income flexibly (by entering a drawdown arrangement)


Taking money from your pension via a drawdown arrangement means you can take income flexibly, as and when you need it. This allows you to take the income you need, rather than a fixed income – which also allows you to manage the tax you pay.


This also means your money stays invested, and has the potential to continue to grow during your retirement. However, as your money remains invested, there is also a risk that you may lose money, for instance if there was a stock market crash, or that you may take more income than can be sustained, which means you could run out of money in your lifetime.


While these risks cannot be eliminated entirely, good advice and planning can mitigate these risks by careful selection of the assets you invest in and by undertaking income planning exercises.


Advantages


  • You can take income flexibly

  • Which means you can take the income you need

  • And manage the tax you pay

  • Everything except the income you take remains invested

  • Which means your money has the potential to grow further

  • A lump sum, typically of 25% of the pension pot, can be taken tax free

  • Flexible death benefits, meaning you can choose who to leave your money to

  • Death benefits tax free in the event you die before age 75


Disadvantages


  • As your money remains invested, your income is not guaranteed and you remain exposed to investment risk

  • So you could suffer losses or experience poor performance

  • Which means you could run out of money during your lifetime

  • Or be left in a position where you cannot take the income you need

  • You will pay charges for the management of your investments

  • And you will likely pay charges every time you choose to take income from the drawdown arrangement

  • Triggers the Money Purchase Annual Allowance (MPAA)

  • More complicated than other ‘at retirement’ options





Take income or lump sums flexibly or your whole pot in one go (using UFPLS)


UFPLS stands for uncrystallised funds pension lump sum. You can probably see why most people call it UFPLS instead.


UFPLS means you can take cash in chunks, or all in one go, and is a way of taking pension benefits without going into a drawdown arrangement or buying an annuity. You simply take lump sums of money from our pension as and when you need it, or all in one go.


Whereas with drawdown or annuities you can take a tax-free lump sum, typically of 25% of your total pension pot, with UFPLS you cannot take a tax free lump sum. Instead, each chunk you take is treated as tax free on 25% of the sum, while the rest of subject to tax.


However, it should be noted that UFPLS is very similar to a flexi-access drawdown arrangement, but offers less flexibility and can be less tax efficient. As such, drawdown is a more popular choice.


Advantages


  • You can take lump sums, or chunks of money, when you need to

  • Which means you can take the money you need

  • And manage the tax you pay

  • 25% of each withdrawal is tax free, leaving only 75% subject to tax at your marginal rate

  • Everything except the money you take remains invested

  • Which means your money has the potential to grow further

  • Fairly simple to understand


Disadvantages


  • As your money remains invested, your income is not guaranteed and you remain exposed to investment risk

  • So you could suffer losses or experience poor performance

  • Which means you could run out of money during your lifetime

  • Or be left in a position where you cannot take the income you need

  • You will pay charges for the management of your investments

  • And you may pay charges every time you choose to take money out

  • You cannot take a tax free lump sum, known as a PCLS, as your 25% tax free allowance is instead applied to each withdrawal

  • UFPLS is very similar to Flexi-access drawdown, but offers less flexibility

  • HMRC will often apply tax at a higher rate than you should pay when you take money out – while this can be reclaimed, this will take time and cause inconvenience

  • Triggers the Money Purchase Annual Allowance (MPAA)



Mix & Match different options


This means you could choose to take money from your pension using more than one of these options.


For instance, after taking your tax-free lump sum, you could choose to split your remaining pension savings between a lifetime annuity policy and a drawdown arrangement. This can offer the best of both worlds, ensuring you have some income guaranteed for life, while leaving some money which you can take flexibly, managing the tax you pay.


This may be appropriate if you are seeking to phase your retirement or continue to work for a time. Our advice and planning can identify whether mixing your options is right for you. While there are benefits and advantages of this, mixing your options can be more complicated and may only be viable for people with larger pension pots.


Advantages


  • You can still take your tax-free lump sum

  • You can guarantee enough income to meet your basic needs

  • While leaving some money invested, which has the potential to grow

  • This allows you to access your flexibly held money when you want to

  • Allowing you to manage the tax you pay

  • Which can mean you have the best of both worlds – some guaranteed income for life and some money which could continue to grow and can be taken as and when you need it

  • Can assist if you are looking to phase your retirement


Disadvantages


  • May only be viable if you have fairly large pension savings

  • You will pay charges for each of the different options, for instance for the annuity purchase and for the management of your investments in drawdown

  • While has the potential to offer the best of both worlds, this also means you take on the disadvantages of both guaranteed income and flexible arrangements too

  • So the guaranteed income is inflexible with limited scope for tax planning

  • While the flexible arrangement is exposed to investment risk

  • Triggers the Money Purchase Annual Allowance (MPAA) depending on the options selected

  • More complicated than other ‘at retirement’ options, or choosing one option only

  • Likely to be a greater need for ongoing advice



How to make the right choice for you


The various options can be confusing, and is often not helped by the use of technical terms and jargon, or by the various different types of products within each broad option.


However, finding a trusted financial adviser to help you develop a retirement plan means you can navigate these choices and make the right choice for you, taking into account the income that you will need in retirement and how much risk you are happy and able to take.



Cash Flow Modelling can help





Cash flow modelling is, in simple terms, a process of assessing your current and forecasted wealth, including your State Pension or any benefit entitlements, any guaranteed income you may have, any other income or assets available to you, and your current and future income and outgoings. This allows you to better understand your finances both now and in the future.


It is often a good idea to undertake cash flow modelling for clients exploring their retirement options, particularly if pensions may be taken flexibly or when there are multiple different sources of income or benefits in retirement. This can paint a picture of the income you will need throughout your retirement, and how much pension savings you will need to achieve this, as well as calculating how much income your current provision will provide for you in retirement and how long your pension savings will last. Last but certainly not least, cash flow modelling is also helpful in understanding the most effective and tax-efficient sequence in which you should take pension income and benefits in retirement.


Cash flow modelling will often also include ‘stress testing’ exercises, to understand what your likely financial position would be in case of an unforeseen event, such as a substantial increase in your income needs when in retirement or large unexpected costs, for instance to pay for social or long term care.



But watch out for the MPAA


You can usually get tax relief on pension contributions up to £40,000 a year or 100% of your taxable salary, whichever is the greater.


However, if you start taking income from a ‘money purchase’ pension, otherwise known as a defined contribution pension – that is, a pension which provides benefits based on the value of your pension pot, rather than a pension which provides a guaranteed income such as occupational final salary pensions – then the amount you can pay into a pension and still get tax relief reduces to £4,000 each year. This reduced allowance is called the ‘Money Purchase Annual Allowance’ or MPAA.


This only matters if you intend to take income from your pension while continuing to contribute to a pension, for instance if you take income from a pension while continuing to work or if you intend to phase your retirement.


Even if you do intend to continue contribute to a pension while taking money from your pension, the MPAA does not always apply. You should seek appropriate professional advice before making any major financial decisions.


#pensions #retirement #financialadvice #retirement planning



IMPORTANT NOTES:


This blog post is not financial advice and is not specific to any individual. This article is intended as generic guidance and comment only, and does not constitute any form of financial or investment advice or recommendation, which is always specific to individual needs. You should not take any actions on the basis of this article, and should take appropriate professional advice instead.


This post was published in April 2020. Legislation and policy may change over time.


All blog posts are written by Dylan Roberts in a personal capacity and do not necessarily reflect the views of Lighthouse Financial Advice Ltd, Lighthouse Group, Quilter Financial Planning, or Quilter plc.

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Lighthouse Financial Advice Ltd is an appointed representative of Lighthouse Advisory Services Limited, which is authorised and regulated by the Financial Conduct Authority

©2020 by Dylan Roberts, Professional Financial & Mortgage Adviser at Lighthouse Financial Advice Ltd