Looking for an alternative to buying an annuity?
When you want to access your pension pot, you have several choices. The right choice for you will depend on a number of different elements, such as your tax position, whether you have a partner, your attitude to risk and even your health.
On reaching retirement, you can buy an annuity to turn your pension into an income. However, the changing nature of retirement means that you may work part-time or stagger your entry into full retirement, so alternatives such as an income drawdown policy may be appropriate for your retirement income and lifestyle needs.
Government review of the rules
If you decide that the most appropriate option for your particular situation is to go down the income drawdown route, you may now receive more from your pension and could benefit from a recent government review of the rules (April 2013). Drawdown is one alternative to purchasing an annuity to provide pension income. It can offer flexibility and the potential to benefit from investment growth, but you need to be comfortable with some stock market risk.
With drawdown, you have a pot of money which is used to generate your income. To help ensure that your money will always provide you with an income, the Government has set rules on how much you can take each year. However, despite this, you can still end up with less income than what you can get from an annuity.
Pensioners keep their pension invested
Drawdown allows pensioners to keep their pension invested and take an income from it each year. The amount of income that can be taken from a capped drawdown policy is based on calculations made by the Government Actuary’s Department (GAD). These are known as the GAD rates, and they follow annuity rates and yields on government bonds or gilts. The income taken can currently be 120% of the GAD rate each year. Because your money is still invested, you are still taking risk with your money, and this includes your income.
Flexible drawdown allows unlimited income to be taken (subject to income tax), but retirees must have another pension income of at least £20,000 a year to rely on, made up of workplace pension, a state pension or a mixture – this is known as the minimum income requirement.
This is because your pension is still invested when it is in drawdown so is at risk of stock market fluctuations. The Government doesn’t want you to fall into poverty and subsequently become reliant on the state.
Running out of money
The Government requires you to re-check your maximum income every three years (and yearly if you are aged 75 or older). If investment performance has been poor or you have taken out a lot of money, then you will have less income to take out in the future.
The government rules are intended to ensure that you don’t run out of money. If investment performance has been good, or you haven’t taken out too much money, your maximum withdrawals could increase. This would give you even more flexibility. However, if investment performance has been poor or you’ve withdrawn the maximum allowed, your withdrawals may decrease.
You don’t have to wait for three years until your next review. You can choose to review your income every year. So if your fund value does increase, then you can benefit from this quickly. It’s up to you.
Impact of announced changes
The gilt yield used in the income calculation has increased to 3.25%, which takes account of the impact of a change which happened in 2013. Last year, the maximum withdrawal limit was also increased from 100% to 120%. So taking these two changes together means that your maximum income could be 33% more if you chose drawdown now as opposed to 12 months ago.
But if you are already in drawdown on the lower 100% income maximum, then it is possible that you could increase your income withdrawals to the new maximum level, including taking account of the change to the gilt yield, but before you do this please seek professional advice.
The value of an investment can fall as well as rise and is not guaranteed. You may get back less than you put in. Taking maximum income every year will increase your chance of reduced income in the future.
Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from taxation, are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future.
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This article featured in our Smart Money magazine and is for your general information only and is not intended to address your particular requirements. This article should not be relied upon in its entirety. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No individual or company should act upon such information without receiving appropriate professional advice after a thorough examination of their particular situation.