Your Retirement Options
With a defined contribution pension scheme like the one we’re developing, under our retirement planning service, you can typically start drawing benefits from your 55th birthday. The value of your pension depends on how much you contributed and how your investments have performed over time.
When you come to choose how you want to take the money from your pension, you have a range of choices.
Since the Pension Freedoms reform was introduced in 2015, defined contribution pensions effectively give you complete freedom to take money from your pension at retirement in any way you choose.
For instance, you could:
- Take a tax-free lump sum and convert the rest into a regular income like a salary
- Taking a tax-free portion and the rest as flexible income whenever you need it
- Taking individual lump sums (including the whole pot) whenever you wish
- Mix-and-match these options as you please
Regardless of the method you choose, the first 25% of your withdrawal tends to be tax-free with the rest subject to tax at your marginal rate.
Once you start drawing benefits the pension is said to be 'crystallised'; you can still contribute to your pension but will have a lower annual allowance (known as the Money Purchase Annual Allowance (MPAA)). Also note that if the total value of your pension pot exceeds the lifetime allowance of £1,055,000 (for 2019/20) you will face additional charges when you draw any money above this level.
Annuity: Regular Income
With an annuity you convert your pension pot into a guaranteed income, much like a salary. In other words, you buy an annuity using your pension pot.
The income may be guaranteed for a number of years or until your death, depending on the terms of your annuity. You can also specify other conditions such as whether the income passes on to your spouse or your dependents upon your death.
When you choose to take your pension as an annuity, you can normally take the first 25% of your pot as a tax-free lump sum (known as the Pension Commencement Lump Sum (PCLS)). You take the rest as an annuity which is taxed at your marginal tax rate.
Remember that once you have chosen an annuity you can’t switch to income drawdown.
Income Drawdown: Flexible Payments
When you come to take your pension benefits, your second option is income drawdown.
With income drawdown you take income from your pension pot as and when you choose while the rest remains invested in the pension pot.
There are two types of income drawdown:
- Flexi-access drawdown (FAD) – here, you take income as and when you please (including as regular income, which makes it similar to an annuity but with more flexibility). You can also take the first 25% of your pot as a tax-free lump sum if you wish.
- Uncrystallised Funds Pension Lump Sum (UFPLS) – here, you take lump sums out of your pot when you need them. With this method there is technically no tax-free 25% lump sum upfront, but every time you take out a lump sum the first 25% is tax-free with the rest taxed at your marginal tax rate.
Overall, income drawdown is generally more flexible and you can withdraw sums when you need them, including the whole pot in one go should you wish. You can also buy an annuity with any unused part of your pension pot.
Also, check out: Comparing defined benefit and defined contributions schemes