With over half a million employers having enrolled their staff into a workplace pension scheme since automatic enrolment was introduced back in 2012, efforts to increase people's general knowledge around the Pension Freedoms rules has never been so important.
Two years ago in 2015, the rules around pensions underwent a huge overhaul, which was announced by the then Chancellor, George Osborne. The aim of this overhaul was to provide people with greater flexibility and access to their pension savings upon reaching the age of 55, increasing to age 57 in 2028. People saving for their retirement through a pension scheme have always benefited from various tax incentives to help them 'grow' their funds. However, the downside to this was always the very limited number of ways in which these benefits could be drawn.
The main purpose of the new legislation was to give people more choice in accessing their retirement benefits. Traditionally, people considering retirement had two options. The first option was an annuity, which provides a guaranteed income until death. However, over the years market rates affecting annuities have fallen markedly because of the increase in life expectancy and fall in Gilt yields. The second option was drawdown which means that pension savings remain within the pension scheme, but income till death is not guaranteed. If incremental income withdrawals are high and investment growth is low, the size of the fund invested would reduced significantly over time.
Following the April 2015 Pension Freedoms changes, people considering retirement now have six choices:
- Leave your pension invested. Delay taking your pension until a later date. During this time your fund will continue to (hopefully) grow.
- Purchase an annuity. All members of pension schemes have the option to take 25% of their fund at a cash lump sum. An annuity is then purchased with the remainder. In choosing an annuity, people have various options such as:
- whether the annuity should remain at a flat rate or increase each year in line with market conditions;
- Whether there should be an attaching spouse's element to the pension;
- whether there should be an element of protection should death occur soon after retirement.
- Flexi-access drawdown. With this option you take up to 25% of your pension fund or of the amount you allocate for drawdown as a tax-free lump sum, and then re-invest the remainder into funds designed to provide you with a regular, taxable income. You decide upon the income you need, however you do have the option to adjust this level of income over time.
- Uncrystallised lump sum. You can use your pension fund to make cash withdrawals as required. The remainder of your fund then remains investment and grow as normal, tax free. Each cash withdrawal benefits from a 25% tax free allowance and the rest is taxed as income. With this choice, your pension fund is not re-invested into new funds and will not provide benefits to dependents upon death. This is a more complex option than the above options with more to consider.
- Take your entire fund as cash. Close your fund and choose to take the entire fund as a single cash lump sum. The initial 25% will be tax-free and the rest will be taxed at your highest tax rate. There are, however, many risks and things to consider when choosing this option, a large tax bill not the least. This option will not pay you or any dependant a regular income, and without careful planning, you could easily run out of money.
- Mixing retirement options. You don't just have to go for one option. You can mix and match at different times to suit your needs. You can also keep saving into a pension if you wish, and get tax relief up to the age of 75. The right choice for one person will be quite different for the next.
As we move through the automatic enrolment cycle, and with the ever changing landscape of pensions and pension provision, understanding retirement options has never been important for members. We suggest seeking the advice of a qualified financial adviser if you are unsure of what your options are.