For those approaching retirement, thoughts are undoubtedly turning to how to secure the right kind of income. Since the pension freedoms came into force in April 2015 you can still purchase an annuity should you wish, but the rules around income drawdown have been relaxed. But, which one is right for you? It's a wholly personal decision, but we've broken a few things down to help clear the minefield.
|Taking an annuity||Not taking an annuity|
|How much of my pension pot will be passed on to my family when I die?||None, unless you pass away during a guarantee period (this is an annuity option that guarantees your annuity will be paid for a minimum period – typically five or 10 years), or opt for Value Protection when you take out your annuity.||Your family will receive any money remaining in your pension pot. This will be taxable if you die aged 75 or older.|
|How much income will I get, or be able to draw down, from my pension?||This will depend on your age, health and a variety of other factors, such as the size of your retirement fund.||There are no restrictions and you can take all of your pension pot in a lump sum.|
|Is this income guaranteed for life?||Yes.||
No. You can only take an income from your pension as long as you have a pension pot! If you end up taking your pension over a long period, there is a risk that you will have a reduced income later on and have to rely on the state or any other assets, savings and investments you have.
|Is there any investment risk?||No. Your annuity is guaranteed for life.||Yes. As your pension remains invested there is the chance that your pot could go down due to poor investment performance.|
|Can I change later on?||
Most annuities will not allow you to change at a later point.
If you wanted to, you could purchase an annuity later.
|What about tax?||Annuity income is treated like employment income and is subject to income tax if your total income is above the income tax threshold.||Income taken directly from the fund is also treated the same as employment income. So if you take all your pot in one go, that (along with any other taxable income you had) would dictate what income tax rate you would pay on the fund. If you had a very large pot, you may end up paying 45% tax on some of it.|
|Are there any other options?||
If you are concerned about leaving your spouse or partner without an income, you should consider a joint annuity that continues until the second person dies. This can be set up to pay the same amount, or a reduced amount after the first death.You could opt for a part and part option, purchasing an annuity with some of your pension pot and leaving some invested and withdrawing an annual income. This could provide an inheritance for your family (providing you have not drawn your entire pot as an income).
* This table does not constitute financial advice. It gives an overview of the different options available to you. If you have any doubt, you should seek independent financial advice.
An annuity is a specially-designed product that can secure an income in retirement. It's purchased when you retire by using the money built up in your pension and will provide a guaranteed regular income every month for life, thereby helping you maintain a decent lifestyle in retirement.
While an annuity can provide you with a guaranteed income for life, it's just that – for life. That means whether you live for another five years or another 50 you'll get your income, but the downside is that if you died after five years, your annuity provider would get to keep the rest of your pension pot (unless this was during a guarantee period or you set up Value Protection). On the other hand, if you lived for another 50 years, you'd probably be on to a winner as the annuity provider would be paying out money they didn't expect to.
If you are 55 or over and own your own home, you could consider using equity release to significantly boost your retirement income. You can normally release up to 40% of the value of your home and continue to live there, usually without having to make any repayments. Learn more or speak to an expert.
Income drawdown could also be an option for you thanks to the increased flexibility. The new rules mean that you can keep your pension invested and withdraw a certain amount from your pot each year rather than having to opt for an annuity. The income you take will be taxed in the same way as employment income.
A key benefit is that, when you die, your estate will benefit from any remaining money from your pension pot, unlike with an annuity where any unused funds can be lost. There may be a tax liability depending on what age you are when you die, but there'll still be money to pass on.
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However, there are some crucial risks with not buying an annuity and leaving your pension invested. Firstly, as your pension remains invested, there is a risk that your pot could decrease if the funds you've invested in don't perform well – and at a time of life when you may not be in a position to replace your losses with new money.
Then there's the risk that you could literally empty your pension pot if you withdraw too much, leaving you with a much reduced income in later years.
The reasons for and against buying an annuity are complex, so we've created the table above to summarise the main differences. Everybody's situation is unique, so this table is not designed to give advice, but to help you come to an informed decision.
As with so many financial decisions, there's no easy answer. The 'Catch 22' is that an annuity becomes better value the longer you live, but over a shorter term will not pay you, or your estate, as much income. The choice you make will depend on what you conceive your pension as being for: is it to provide you with income in your retirement, to provide a financial legacy for your family, or a combination? That decision comes entirely down to your own individual circumstances and preferences, but thanks to the new rules, at least now there are more options.
Choosing how you will take your income in retirement will possibly be the biggest financial decision of your life, so be sure to enlist the services of a good financial adviser and always shop around to maximise your income, no matter what route you choose to go down.
Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.