Several options including a pension lump sum and income drawdown are available with a pension making retirement planning increasingly important.
With the continued uncertainty in global shares and the general economy combined with the closure of a number of high-profile final salary pension schemes and changes in the state pension age the pressures on the individual to save and plan for their retirement have never been greater. However, some pension options are available in order to make the most of retirement.
The State Pension and when to Retire
The first key decision to make is when to take the pension benefits and retire. The minimum age to be able to take pension benefits is currently 55 with the state pension age changing in response to people living longer as advancements in medicine continue to prolong lives. Historically the state pension age for women has been 60, with the state pension age for men at 65. By 2046 the state pension age will be 68 for both men and women.
An increasing number of people are choosing to carry on working beyond the minimum retirement ages. There is no maximum age that a pension must be taken by but after the age of 75 the rules concerning how a pension can be taken are more restrictive. An individual may potentially spend up to a third of their life in retirement and due to this many will carry on working whilst in receipt of a pension.
Pension Lump Sum
A proportion of a pension can be taken as a lump sum once the minimum age has been reached. The normal percentage of the pension that can be taken as a lump sum is 25%. However, some plans enable the policyholder to take a higher percentage than this. The lump sum can be used in a variety of ways from paying off any outstanding debts to a luxury holiday.
This lump sum is tax free whereas the remainder of a pension, which is referred to as an annuity or income for life, is taxable. However, the disadvantage in taking the tax-free cash entitlement is a reduction in spending power in retirement. This is because the value of the pension in retirement has effectively diminished by a quarter of the value.
Income Drawdown and Phased Retirement
An individual may be able to take the tax-free cash lump sum element of their pension without the need to take the remainder of their pension as an annuity, or income, at the same time. This is referred to as income drawdown, where an income is taken in stages. In order to be eligible for income drawdown a minimum fund of at least £100,000 will normally be required due to the costs involved.
Phased retirement enables the individual to gradually receive an income from a pension and is ideal when someone wants to gradually retire and replace their lost income from a reduced salary with their pension. The main risk to this approach is that the portion of the fund that remains invested may diminish in value if the fund underperforms.
QROPS Overseas Pension Schemes
QROPS stands for Qualified Recognized Overseas Pension Scheme, which is an overseas pension scheme that meets specific requirements set by HMRC. have been around for well over a decade now. There are high tax and financial benefits if you transfer your money to a QROPS to withdraw money from, so it is worth looking into if you plan on retiring abroad or are working overseas.
Ex-pats are most suited to QROPS pension transfers. One of the biggest advantages of a QROPS is the level of flexibility you attain regarding income payments. It is usually possible to withdraw larger lump sums and you can request to receive your pension in the local currency of your residence.
The Need for Pension Advice and Pension Annuities
Many people however will simply take the pension lump sum and then an annuity income all at the same time when they retire. The importance of getting the best annuity rate cannot be underestimated. It is worthwhile making the most of expert financial advice when taking a pension as an individual does not have to take their pension from their existing provider.
The amount of income gained from an annuity, much in the same way as when shopping for insurance, can vary depending on the provider and the health of the applicant. An open market option is available when purchasing annuities and if in poor health an impaired annuity may be available which offers an increased level of income.