Back in 2015, Chancellor George Osbourne overhauled the pension system and introduced Pension Freedoms. The changes gave pensioners a greater number of options at retirement and more control over how they received their benefits.
Increased ‘flexibility’ meant more responsibility for future budgeting too.
Five years on and Money Observer reports that Pension Freedoms account for more than £35 billion withdrawn from pensions by 1.4 million individuals.
And yet initial concerns that retirees would withdraw their pension assets irresponsibly, leaving themselves insufficient funds for later life, have proven largely unfounded.
Tom Selby, a senior analyst at AJ Bell, says that “average per person withdrawals have fallen steadily since April 2015, suggesting people are generally using the reforms sensibly to take a steady income rather than splurging their hard-earned retirement pot in one go.”
Meanwhile, the ‘traditional’ Annuity continues to offer regular and reliable retirement income. Inflexible, but useful for paying fixed, known expenses, the rates on offer have been dropping in the last year, hitting ‘an all-time low’ in 2019, according to an FTAdviser report.
Which option will you choose?
Pension Freedoms: the options
- Uncrystallised Fund Pension Lump Sum (UFPLS)
An UFPLS allows you to take the whole of your pension pot as a single lump payment. A quarter of your pot will be paid tax-free, with the remaining 75% taxed at the highest rate of tax you pay.
You might be able to take multiple UFPLS payments, all taxed the same way, although this will depend on what options your provider offers.
You might consider an UFPLS if you have plans for large, one-off expenses during your retirement – world travel or helping a child onto the property ladder for example. A lump sum frees up large amounts of money in one go, for you to do with as you wish.
It’s important to remember though that your pension pot might comprise your entire retirement income. You’ll need to make sure the amount you take can sustain your desired standard of living for the rest of your life.
Once a full UFPLS is taken, it extinguishes all rights under the scheme, there is nothing left to pay and the responsibility for budgeting rests with you.
You should also be aware that an UFPLS could push you into a higher tax bracket. The large one-off payment will be taxed on a ‘month 1’ basis by HMRC – effectively reducing your annual allowance to a 12th of its usual amount. You can claim the tax back, but this can be time-consuming.
- Flexi-Access Drawdown
The Drawdown option would allow you to take up to 25% of your pension pot tax-free whilst using the remainder to provide an income.
The difference between an Annuity and Drawdown is that the remainder of your pension pot stays invested. Also, you can withdraw an income, or ‘drawdown’ funds, as and when you choose. This gives you the flexibility to take the exact amount you want when you most need it.
As with an UFPLS, the responsibility for budgeting falls on you so you’ll have to keep track of the amount you’re drawing down. Remember that when stock market prices are lower, you’ll need to sell more units to achieve the same level of income.
This option gives you a large amount of flexibility. This can be especially useful if your fixed expenses are covered elsewhere, with your pension mainly being used for ad hoc, discretionary expenses.
Finally, you’ll also need to be aware that ‘flexibly’ accessing any taxable funds you hold in a Defined Contribution (DC) scheme will trigger the Money Purchase Annual Allowance (MPAA).
The MPAA reduces your Annual Allowance – the amount you can contribute to a pension and still get tax relief – to £4,000.
The traditional option: An Annuity
The ‘traditional’ retirement route pre-2015, was an Annuity. It’s a regular income, paid to you for the rest of your life.
You have the option to take up to 25% tax-free cash with the remainder used to purchase your pension. It is paid on a frequency agreed at the outset and can often include additional benefits such as a spouse’s pension or an income that rises each year to combat inflation. These additional benefits will lower your starting pension amount.
Because you need to select your pension basis at the outset, this is a much less flexible retirement product than those on offer through Pension Freedoms.
A regular amount, received on a pre-selected frequency, can make budgeting easier though, as well as giving you peace of mind.
What about a combination of both?
You might consider the ‘best of both worlds’ approach, mixing and matching flexible and traditional options to suit your needs.
You could take an Annuity to cover fixed expenses whilst accessing other funds flexibly to cover discretionary expenses as and when required.
Remember that different options give you different responsibilities for budgeting and that whatever you choose, your pension fund should enable you to live your desired lifestyle, for the rest of your life.
Get in touch
If you are approaching retirement and would like to discuss the best options for you, please get in touch. Email at email@example.com or call 0800 0787 182.
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 the 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 which are subject to change in the future.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation which is subject to change.