The importance of preparing for your retirement should never be underestimated. While you may have been contributing to a pension your entire life, you need to explore all of your retirement income options carefully. Once you hit the age of 55-years-old in the UK, you can start to retire. But, just how are you going to use your pension once you do take your retirement?
How are you going to fund your lifestyle? What options are available to you? Read on to discover more about your different retirement income options, including pension freedom.
What Is Pensions Freedom?
Several years ago, pensions freedom legislation was introduced, providing retirees with more options in terms of how they use their pension. Prior to this regulation, there were very few options available to you with regards to generating a retirement income from your Direct Contribution pension pot. By law, you were forced to take out an annuity if you reached the age of 75-years-old without touching your pension pot. However, this all changed back in 2014 when the annual Budget was announced. This changed the way retirees were able to use their pension savings, and it did so drastically.
As always, you have the option of taking a quarter of your pension pot as a tax-free lump sum. Nevertheless, for decades, the vast majority of retirees needed to use the remainder of their pension to purchase an income annuity. This is a product that pays you an income per annum until you die. Announced in 2014, but implemented at the start of the 2015/16 tax year, pension freedom meant that anyone over the age of 55-years-old could take out his or her entire pension as a lump sum. If they opted to do this, the extra 75 per cent would be taxed at their income tax rate as if it were a salary.
Pension freedom is applicable to money purchase pensions or defined contribution pensions. These are private pensions whereby you and/or your employer have saved up a retirement pot of cash. This is not applicable to state pensions. Moreover, you only have the option to take out the cash once, after you turn 55-years-old. Of course, you don’t need to take out the money straight away, though, and it’s better if you do not, especially if you are still working. Keeping the money in your pension will give it more chance to grow until you do need to take it out.
What Are the Various Options?
Thanks to pension freedom, retirees now have more options than ever before in terms of retirement income. Nevertheless, you may have decided that you do not want to take all of your money out. It is always advisable to be fully aware of all of your options before making a decision. So, what other avenues are there in terms of retirement income?
Take 25 per cent tax-free and then buy an annuity – This is what the vast majority of people were doing before the changes came into place. If you do this, you will have a guaranteed income each year for the rest of your life, which will give you peace of mind. There are different charges on annuities, as there are many different providers offering this service. Therefore, it is critical to do your research carefully. A lot of people believe that annuities represent poor value because of the low rates that we have experienced for the past ten years. While this is true, at least you know what you are getting and you have a level of security. It all depends on your individual circumstances. For some, the removal of risk will be paramount. It is also worth pointing out that there are a number of different annuity products available. Some of the more exotic types enable you to have an income for a specified period of time, and then you can have money released back to you at a later date.
Take 25 per cent tax-free and then buy a flexible income drawdown product – Another option is to, again, take the 25 per cent tax-free lump sum, yet instead of buying an annuity, buy a flexible income drawdown product. This is a product you purchase that keeps the rest invested, with the aim of, hopefully, growing the investment. However, you will also have the option of being able to take the income whenever required. The difference between this option and the next option we are going to discuss, which is to leave the money invested in your pension, is that you with an income drawdown product any money you take at a later date is taxed when you need it. This can prove to be beneficial if you are going to be in a lower-tax bracket when you are older. A lot of people view this as the option with the most value, as it provides flexibility and often more money too. However, you need to manage the risk that comes with this.
Leave the money invested in your pension until you need it – This is another option, which is known as an Uncrystallised Funds Pension Lump Sum (UFPLS) yet if you do go down this route it is very important to understand how the tax works. This is the key difference between this and the former point. With this solution, whenever you withdraw cash, you will get 25 per cent of your withdrawal tax-free. Therefore, if you have £100,000 and you withdraw £25,000; you won’t get this all tax-free. You will get 20 per cent of the £25,000 tax-free, so that would be £6,250.
What Should I Consider When Choosing My Options?
Now that you understand the different options that are available to you, you need to decide how you are going to approach your retirement income situation. You could, of course, do nothing and allow your investment to grow. Alternatively, you can take out some of the money to keep yourself going via a flexible drawdown or a UFPLS. Another option is a small pension pot. If you have a small pot, i.e. a pension that is less than £10,000, you can withdraw all of this with no tax to pay. You could also take out an annuity, or live off other money, for example, a part time job or savings. But, how do you decide which route to go down?
The first thing you need to do is figure out how much money you are going to require for your retirement. Do not forget to consider the different factors that will influence how much money you need, for example, your partner and his or her requirements and situation. You also need to factor in inflation, as everything will cost more in years to come, and whether you want to leave any money to your family when you pass way. Your health, insurance, and care costs also need to be factored in. This will help you to come to a realistic figure regarding the money you will need. Do not downplay or overlook any costs.
Once you have done this, you will be in a position to figure out the best way for you to get the retirement income you require based on your individual circumstances. Your attitude to risk will also play a key role. If you are someone that does not like taking a lot of risks, you may prefer the security that an annuity can provide later in life. On the other hand, if you are not averse to risk, one of the more flexible options is often the better approach. This is especially the case if you can mitigate the risk because you have other income sources. Other factors that will influence your decision include whether your circumstances are likely to change in the future, the size of your pension pot and other savings, your income objectives, whether you have financial dependents, when you store or reduce work, and your age and health.
It is important to acknowledge that there are many ways to make sure that you have enough money for your retirement, and therefore, a lot of different factors you need to consider before the time comes. For example, you may want to consider looking at different ways to add more money to your pension pot to make sure that you have more available in the end. Use an overtime calculator to see how much extra money you could make and put toward your future. Of course, making money online is something more and more people are doing today, and so this is something that is worth looking into in further detail as well.
There is no denying that there is a lot that must be considered in concern to retirement income options. Take the time to really think about what is going to be right for you. Everyone is different and it depends on your circumstances.