FLEXIBLE PENSIONS - HOW TO DECIDE YOUR RETIREMENT OPTIONS
- Flexible pensions – Simon’s story
- Simon’s choices at retirement
- Options under flexible pensions
- Why did Simon decide against flexible pensions?
- Why use flexible pensions?
- Get our free retirement checklist
Flexible pensions – Simon’s story
Simon came to us seeking advice on flexible pensions. He is nearly 65, and is thinking about retiring. When he retires, he will receive a number of pension benefits, and wants to maximise his income when he retires. He will be swapping a regular, secure income from his employment for a different income when he retires. This means that security is important to Simon.
Simon is also aware that he has some new choices on some of his pension schemes. This is causing him some confusion since he likes the idea of flexibility in his future. He wants to make sure that he makes the most of his retirement pots, and does not want to make the wrong decisions.
Simon has 3 main sources of income when he retires:
- A final salary company pension – payable when he reaches age 65
- 2 personal pensions from his current employer and a previous employer – payable when he decides to take his retirement benefits
- The State pension – payable from age 65
Simon’s plan is to retire when he reaches age 65. He will be entitled to receive his final salary pension and his State pension at this date.
He wants advice on how to proceed with his personal pensions as he has heard a lot in the press about flexible pensions.
“The new flexible pensions rules allow you to decide how and when to take taxable withdrawals from your funds. This gives you the maximum control over your finances.”
Final salary pension
Simon does not have much of a choice here. Since his employer owns this pension scheme, he must wait until age 65 to receive his pension income. He will need to decide whether to take the full pension, or to reduce this and take a tax-free lump sum.
Simon can choose from the following options:
|Option||Taxable pension per year||Tax-free lump sum|
Simon’s wife will receive 50% of the pension if he dies before her.
Simon decides that he will take the full pension offered by his final salary scheme since he has other savings and his primary need is for a guaranteed income.
The State pension will pay out when Simon reaches age 65 in a few months. Find out your State pension age here.
Simon has received his State pension forecast, and knows that he will receive the following:
|Basic State pension||£5,881.20 per year|
|Second State pension||£1,118.80 per year|
|Total State pension||£7,000 per year|
Simon will need to claim his State pension when he becomes entitled to receive it.
If you are retiring after April 2016 you will get the new flat rate State pension.
Simon has 2 personal pensions, worth approximately £100,000 in total. He has received a bewildering array of paperwork from each product provider, but needs some advice on what to do.
Simon’s main options
For the sake of simplicity, we have excluded some of the retirement options open to Simon. Before you make any decisions, we recommend you seek advice from a pensions adviser.
Tax-free lump sum
Simon can take up to 25% of his pension fund as a tax-free lump sum. In Simon’s case this would be £25,000.
The traditional annuity route is still open to Simon. He can take his pension fund, minus any tax-free lump sum, and use this to buy a guaranteed income for life. This option is attractive for Simon since he wants security for his future income. The downside is that the rate of income payable is relatively low compared to previous years. Nevertheless, the annuity seems like a sensible choice given that it will guarantee his income for the rest of his life, no matter what happens. Since Simon will not earn this money again, the idea of taking any risks with his savings is a little scary.
Simon could move into another type of pension plan called Income Drawdown. This would allow him to take the tax-free lump sum of 25% of the fund (£25,000).
Instead of taking a guaranteed income for life as under the annuity route, Simon would instead take a flexible income based on the annuity income available to him. He could take between 0% and 150% of the annuity income available to him.
The pension fund would remain invested, which would mean that it could grow or lose money. The fund could be used to pay a taxable lump sum to his wife if he dies. In Simon’s case, since his wife has pensions in her own right, and he does not want to take much investment risk, he decides against the income drawdown option.
New flexible pensions
New rules on flexible pensions have been announced from April 2015 onwards. See here for our summary of the main rules on flexible pensions from April 2015. The new rules have the catchy name of Uncrystallised Funds Pension Lump Sum (UFPLS).
Under the new flexible pensions rules Simon can do one of 3 things differently:
- Take all of his fund minus tax
- Take ad hoc payments minus tax
- Take a flexible regular income minus tax
For the ease of calculations we have assumed that Simon does not have any further earnings in the current tax year.
As soon as Simon accesses his pension under income drawdown or UFPLS he would only be allowed to pay up to £10,000 each year into any future pension plans into which he contributes. This limit is scheduled to reduce further to £4,000 from April 2017.
Taking all the fund under flexible pensions
If Simon takes his entire fund under flexible pensions, the following would happen, assuming he takes the full final salary pension listed above.
Simon has a personal pension fund of £100,000. £25,000 can be taken tax-free. The remainder would be added to his income for the tax year and taxed in the usual way.
Therefore, his tax situation might look like this:
- Final Salary – £18,000
- State pensions – £7,000
- Taxable portion of personal pensions – £75,000
- Total taxable income – £100,000
Simon would pay 0% tax on the first £10,000 of pension income. Tax would be paid at 20% on the next £31,865. The remainder would be taxed at 40%.
The calculation would look like this:
|Income before tax||Rate||Tax|
Taking ad hoc payments under flexible pensions
The new flexible pensions rules allow Simon to take any amount from his pension schemes. At each stage he can take up to 25% of the fund tax-free, and the remainder will be taxed as income.
Therefore, he can decide to take the £25,000 initially, and then withdraw payments designed to boost his income for that tax year, or even up to the 20% income tax limit.
If he decides to do the latter he could release £23,865 in the current tax year, paying 20% income tax on this amount of £4,773. Any income from the pension fund over this limit would be taxed at 40%.
Simon could continue to do the same for the next few years. This should reduce the tax paid on the option of taking the whole fund.
Regular income under flexible pensions
As an alternative to an annuity, Simon could instead take a regular income from his pension fund. This would mean that his fund would remain invested, although he could decide to reduce the risk he is currently taking. This could mean that his personal pension pots last longer if Simon takes sensible investment decisions. Of course, this option is not guaranteed, unlike the annuity option.
What Simon decided
Since Simon’s primary concern was security of income in retirement he decided to take a traditional annuity product. This would give him the guarantee he wanted rather than having to assume the risk for himself. Tweet this.
Why might you decide to take a flexible pension in retirement?
You might choose a flexible pension in retirement for any of the following reasons:
The new flexible pensions rules allow you to decide how and when to take taxable withdrawals from your funds. This gives you the maximum control over your finances. This will be attractive to many people, although will require some careful management of your funds to make sure that they do not deplete too quickly. See how we do this through Financial Planning and Investment Management.
Potential increases in income
By keeping your pension money invested you could increase your retirement income over the long-term. Of course, the reverse could be true.
Passing your fund to your family
The major downside of the traditional annuity is that the fund is usually lost when you die. By keeping the money in your pension plan, you could pass on some of the fund to your dependents when you die.
Your flexible pensions retirement options
If you want to consider your flexible pensions retirement options, the easiest way to get started is to download our retirement income checklist. Just fill out your details in the box below.
Otherwise, you can contact us to discuss this in more detail.
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About Dan Woodruff
Certified Financial Planner & Chartered Wealth Manager at Woodruff Financial Planning
Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.