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Pension Freedoms or ‘traditional’ Annuity: What pension option will you choose?

Category: News & Pensions

Pension Freedoms introduced greater flexibility into the process of receiving retirement benefits.

By allowing pensioners to access all their money in one go, the government gave freedom to enjoy retirement but added responsibility.

If you’re nearing retirement and trying to decide how best to take your benefits, read about the pros and cons of your available options here, and then speak to us.

The flexibility of Pension Freedoms

Introduced in 2015, Pension Freedoms offer you flexible options, including:

  • Taking all of your pot in one go as a lump sum
  • Taking a series of lump sums
  • Making flexible withdrawals as and when you need them.

An Uncrystallised Fund Pension Lump Sum (UFPLS) allows you to free up a large amount of cash in one go. You’ll usually be entitled to 25% of the value of your pension pot tax-free, with the rest taxed at your marginal rate.

You might also be able to take a series of UFPLS payments, dependent on your provider. Each would be taxed in the same way.

A lump sum frees up a large amount of money in one go so could be great if you have large, one-off items that you intend to spend money on in retirement. This could be world travel, building renovations, or helping your children onto the property ladder.

You’ll need to be sure that your fixed expenses are covered though. This might be through investments held elsewhere, for example, or by income from Buy to Let properties.

The important thing, as with all flexible options is that you budget sensibly and remember that your retirement pot is designed to provide you with an income for the rest of your life.

Flexi-Access Drawdown allows you to take your 25% tax-free cash entitlement while leaving the rest of your pot invested. You can then withdraw – or ‘drawdown’ – an income from it as and when you need to.

The option is flexible because unlike an Annuity, you have control over the frequency and level of payment. As with the UFPLS, this leaves you in charge of budgeting.

Be sure to access money only when you need it. Withdrawing more than you need not only depletes your fund but holding the withdrawn amount in cash for a long period could see it start to lose value in real terms.

Accessing too much in one go might also mean income tax is due – the Personal Allowance for the 2020/21 tax year is £12,500 – and you could push yourself into a higher tax bracket.

Greater flexibility can make budgeting harder and the emphasis is on you to ensure your remaining pot will allow you to maintain your desired lifestyle for the duration of your retirement.

The Money Purchase Annual Allowance (MPAA)

As well as greater responsibility for sensibly budgeting the pension pots you access, you might also find yourself limited in the amount you can contribute to other pensions you hold. This is because accessing benefits ‘flexibly’ – taking taxable income from your pension using one of the Pension Freedoms options – triggers the MPAA.

This lowers your Annual Allowance – the amount you can contribute to pension plans you hold and receive tax relief on – from £40,000 to £4,000.

If you intend to keep making pension contributions, you’ll need to be aware of this reduced allowance when accessing benefits.

The regular income of an Annuity

Before 2015, pensioners reaching retirement would receive a regular, lifetime income –  an Annuity. Because they pay a regular, known income for life, Annuities keep budgeting simple and are perfect for covering known, fixed expenses such as monthly bills.

As with flexible options, you’ll usually be entitled 25% of your pension pot tax-free, known as Pension Commencement Lump Sum (PCLS). The rest of your pot is then used to buy your lifetime income.

This includes the payment frequency and additional benefits such as a spouse’s pension that would continue to be paid to your partner when you die, or a pension that increases each year to combat the effects of inflation.

Both of these options will decrease the amount you receive initially but you’ll have the peace of mind that your partner will be looked after when you are gone, or that your pension will rise with the cost of living.

The inflexibility of a lifetime income

An Annuity is inflexible. Once an Annuity is set up it can’t be altered and will continue to pay the agreed amount until you die. The whole pension pot is used up and there is nothing more to pay, nor no way of accessing future payments early.

A lump sum is limited to 25%. If you’re looking to use retirement to renovate your house or travel the world, for example, you might be looking to access a large element of your pension pot in one go to fund it.

By taking all your fund as an Annuity, you limit yourself to 25% of your pension pot as a lump sum.

Consider a combination that suits you

If you’re struggling to decide between the hassle-free ease of a fixed and regular Annuity or the responsibility of budgeting a large one-off sum, consider a combination.

You could use a traditional Annuity to pay for fixed expenses but take a separate amount flexibly, making withdrawals as and when you choose to cover discretionary expenses such as holidays.

There’s no right answer, only what works best for you. But by understanding your financial situation and your long-term goals, we can help you to decide so get in touch.

Get in touch

Please contact us if you’d like to discuss the best pension option for you.

Please note:

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.

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