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The Pensions Crossroads

How you draw income from your pension plan is one of the most crucial choices you can make about your retirement. The difference between making the right and wrong decision can be the difference between a comfortable retirement and ‘getting by’. There is now a wide range of options, thanks partly to the pension tax changes introduced in April 2006. In practice two routes are dominant: annuities and income drawdown.

Annuities
The pension annuity is the traditional way of converting a pension fund into a regular income. It has the great virtue of providing payments throughout your life – however long that may be. These payments are guaranteed, unless you choose an investment-linked annuity.

The annuity market is fiercely competitive, but its elements can vary from those in the pension plan market. A good pension plan provider may only offer poor annuity rates, making it very important that you do not accept what your provider offers without first checking with us what is available elsewhere. Industry figures suggest that by shopping around you may be able to improve your pension by as much as 30%.

There have been a number of innovations in the annuity market over recent years, one of the most significant being the spread of enhanced annuities. These offer you higher rates if your health or lifestyle is less than 100% perfect. For example, if you are a smoker or have diabetes, you could qualify for a better annuity rate.

Income Drawdown
Income drawdown is generally a higher risk strategy than buying an annuity and on the whole is only suitable for those with a range of other sources of retirement income. As the name suggests, under income drawdown your retirement income consists of taking withdrawals – regular or one-off – from your pension fund. Her Majesty’s Revenue & Customs (HMRC) set a maximum withdrawal level and require that withdrawals stop by age 75, at which point you must either buy an annuity or switch to an ‘alternatively secured pension’.

Income withdrawals have a number of advantages over annuities to set against the greater risk:

If you die before age 75, the value of your remaining fund can be paid out as a lump sum. This is subject to a 35% income tax charge, but normally inheritance tax will not apply. Alternatively the full value of the fund can be used to provide an income for your dependants.
You can vary the withdrawals you take each year from nothing to about 120% of what an annuity would provide.
You do not have to make up-front decisions about dependants’ benefits. In contrast, if you make the annuity choice, you have to buy the dependants’ benefits at the time you set up the annuity.
You can continue to control where your money is invested and you are not tied to the fixed interest investments that underpin traditional annuities.

Greater investment potentially means a better overall return, but you should remember that investment values can fall as well as rise and there is no certainty you will outperform an annuity. Some income drawdown providers now offer an income guarantee, which has created an interesting halfway house between the annuity and full risk income drawdown.

For advice on your pensions options call Daly Harvey Morfitt on 01789 299655 or use the contact form here.

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Daly Harvey Morfitt. 8 Shottery Brook Office Park, Timothy's Bridge Road, Stratford-upon-Avon, CV37 9NR. Tel: 01789 299655 Fax: 01789 264685