You can cash in your pension from 55 rather than buying an income for life in the form of an annuity. It is called income drawdown and here’s the lowdown on drawdown.
If you are lucky enough to have a final salary pension, the scheme does the legwork for you. Your income will be according to your salary at retirement and how long you have been in the scheme, not based on how much you have saved.
Most of us have money-purchase schemes that mean our retirement income is determined by how much we have saved. Your pension pot at retirement is dependent on how much you have paid in and how well those funds have performed as investments. Your savings are held in shares, bonds and other assets. When you retire, you will convert that pension pot into an income.
You’ve spent your working life building your pension pot. So, you shouldn’t rush into how you are going to use it without a complete financial plan for the rest of your life. It is one of the biggest financial decisions you will ever take and it needs professional advice.
Most people can expect to live well over twenty years after they retire and you will need to consider how your outgoings will change as you get older.
What is an annuity?
You can convert your pension into income by purchasing an annuity. That’s a financial product pays you a guaranteed taxable income for a set time. It is bought with your pension pot and can give you certainty throughout your retirement, or at least the guaranteed period.
What is income drawdown
Income drawdown starts with investing your pension pot and drawing an income from it by cashing in some of those investments. You can withdraw it all in one go, take regular payments or take lump-sum payments when you want them.
Just as when you were saving your pension pot, it’s invested in shares, bonds and so on. There is no limit on how much income you can take from your drawdown funds, but there will be tax implications.
You can take up to 25% of your pension pot as a one-off tax-free lump sum. Whether you buy an annuity or choose to draw on your pension fund.
Subsequent income drawdown withdrawals are subject to income tax. Here are the 2016/17 rates.
- No income from any other sources, the first £11,000is tax-free.
- You then pay tax at 20%on income between £11,000 and £43,000 .
- You then pay tax at 40%on income between £43,000 and £150,000
- You then pay tax at 45%on everything above £150,000.
Here’s an example. If you draw down £20,000 and had no other income from private pensions and the state pension, your tax bill would be £1,800. (£20,000 – £11,000 = £9,000, then £9,000 x 20%)
The Association of British Insurers data shows over 90,000 savers invested in drawdown plans compared with just 6,700 in the first three months of 2014. Research by MetLife found that more than one in five admit they did not understand the risks and over one in ten were unhappy with their decision.
Leaving your pension fund invested is riskier than locking it into an annuity. The value of your investments can go up and down. Given the market volatility of the last 18 months, you can see why so many people may be having second thoughts. In fact, MetLife’s research found 25% had suffered losses from income drawdown over 2016. Income drawdown isn’t for you if you’re worried about future volatility.
Income drawdown enables you to enjoy any future stock market growth. Plus, it gives you the flexibility to manage your cash flow according to your specific needs – only drawing on your income when you need it.
The income you can expect from your investments will depend on how much you invest and how well they perform. As stock markets rise, so will the value of your investments. Of course, that means the value can go down if the markets do.
Income drawdown is generally a better fit for people with larger pension pots. We suggest you need at least £100,000 to make it viable. Otherwise fees and charges could erode your capital sum. You are better placed to weather stock market volatility with a larger pension pot.
An investment-linked annuity is the halfway house. It combines the flexibility of drawdown with the security of an annuity. Your retirement income will vary with the value of your investments. You usually have a choice of funds to invest in, or can use the provider’s default with-profits fund. You can see the benefits of investment growth, but if they fall, you’ll have a minimum income guaranteed.
Investment-related annuities have higher charges than a basic lifetime annuity, so you need to make sure you have taken advice to see how this could affect your capital sum.
We have set out how to review your investments for whatever this year has in store in our recent piece, investing in 2017.
With either approach there is a risk of running out of money if you live longer than expected.
If you would like to help with your 2017 financial plan, especially planning how to access your pension funds, get in touch today.
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.
Your pension income could also be affected by interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, all of which are subject to change in the future.