Pensions have changed a great deal in recent years – and quite possibly since you first took out your pension.
Pension freedoms came in April 2015 and a complete shake-up of the UK’s pensions system, giving more choice over your pension savings than before.
Before the freedoms, virtually the only way to access your pension pot was by using it to buy an annuity. This was an income guaranteed for the rest of your life, which might sound ideal – were it not for the fact that low interest rates meant that even with a large pension pot the level of income offered by an annuity could be very low. Most people simply went with the annuity their pension provider offered, although it was possible to shop around for the best rate.
Pension freedom provided other ways to use the wealth you had built up, and pension drawdown is one of the most popular.
How does pension drawdown work?
With an annuity, your pension pot is no longer invested, and in fact the money in it is no longer yours. With pension drawdown, also known as income drawdown, you keep your pension pot invested, and withdraw some of the money from it to provide you with an income that can be paid regularly or as an annual lump sum.
If you have enough money in your pot, you might be able to withdraw enough to live on while your remaining capital goes on growing.
However, the income you receive will depend on the performance of your funds. If the underlying investments do well, your pension fund could grow, and you might be able to up your retirement income. But there are no guarantees. The arrangement is not risk-free and if your investments perform badly, the value of your income and your pension fund could go down.
One of the other innovations of pension freedoms was the ability to take some of your pension pot as a cash lump sum. You can take up to 25% as a tax-free lump sum and some older schemes might let you take more. You can also make partial withdrawals and use the 25% tax-free cash more gradually.
Can you choose drawdown?
You could be eligible for pension drawdown if you are aged 55 (soon to go up to 56) or over and belong to a defined contribution scheme or have a personal pension such as a SIPP (self-invested personal pension).
There are two main types of drawdown pensions. Those set up after 6 April 2015 are flexi-access drawdown plans and any set up before that date are capped drawdown plans.
With a flexi-access plan you can withdraw up to 25% of your pot as a tax-free lump sum and there is no limit on the income you can take.
With a capped plan you can also withdraw 25% of your pot as a tax-free lump sum but the income has an upper limit equivalent to 150% of an annually calculated Government-set annuity, which places a serious restriction on what you can do with your money.
The choices don’t end there
However, if you have a capped drawdown plan you may be able to transfer to a flexi-access drawdown plan. But you need to look at the figures carefully. Flexibility can often mean extra pension costs. On the other hand, income drawdown could be the more suitable choice if you don’t want to take all of your pension immediately, if you plan to carry on working part-time or if you have income from other savings or investments.
At Continuum we can help you look at your pension arrangements and ensure that they are working at their best for your future, and help find ways to make your existing pension savings work harder.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable retirement strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested.
A pension is a long term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Pension income could also be affected by interest rates at the time benefits are taken.
The tax treatment of pensions in general and tax implications of pension withdrawals will be based on individual circumstances, tax legislation and regulation, which are subject to change in the future.
Accessing pension benefits early may impact on levels of retirement income and your entitlement to certain means tested benefits.
Accessing pension benefits is not suitable for everyone. You should seek advice to understand your options at retirement.