What are my options?

What is your retirement strategy and what income/cash do you want to achieve to meet your objectives on time? Are you on target? Taking retirement planning advice early (around 6-12 months before your intended retirement date) is usually worthwhile.

Financial planning is key to meeting your objectives, whether you plan to stop work entirely or reduce your workload as you ease into retirement. Having sufficient capital to provide income and cash to meet your needs, whatever they are, both expected and unexpected, is important.

There has been much recent press about changes to pensions legislation and the increased flexibility in the way that pension benefits can now be used and drawn.

These significant pension benefit changes came into force from 06 April 2015. It should be clearly noted that the principle that a pension should provide you with income for the rest of your life does not change. Therefore, although these new changes are welcomed, the financial planning approach to any new changes should be balanced to take this longevity into account.

You may have accumulated various type of pension plan and some of these are detailed below:

Personal Plans, Retirement Annuities, Stakeholder Pensions & SIPPs

Since the introduction of stakeholder pensions in 2001, new pension plans have become more flexible with lower charges. Some of the older type schemes, such as Retirement Annuity Policies (RA 226) and Executive Pension Plans (EPPs), can have significant advantages such as guaranteed annuity rates and the level of tax free cash available. These need to be checked to understand the significant value that they could offer. Other alternatives may include Self Invested Personal Pension Plans (SIPPs).

Occupational Pension Plans, Final Salary & Money Purchase

These have become very topical subjects in recent times, usually for the wrong reasons. Careful advice needs to be sought to ensure that the employee gains the real benefit that was originally offered by the employer and from any Additional Voluntary Contribution (AVC) fund or Free Standing Additional Voluntary Contribution fund (FSAVC) they have accumulated, and that the employer controls their costs. We can offer you advice on these plans to meet your individual needs.

Other types of plan can include Small Self-Administered Schemes (SSAS), Executive Pension Plans (EPPs), Final Salary (Defined Benefit) and Money Purchase (Defined Contribution) arrangements.

We provide a full advice service for Defined Benefit Transfers (Final Salary) arrangements. Please note that we will not sign off pension transfers without conducting a full review and transfer analysis. If our recommendation is not to transfer we will not subsequently act contrary to that advice to arrange the transfer for any insistent clients (where the client elects to reject the advice and proceed with the transfer anyway). We charge for the transfer review and recommendation so our fee would still be due even if we recommend not to transfer.

Accumulation of Pension Benefits

Charges, term, contribution level, investment choice. All these are mixed into your retirement fund and may influence its outcome.

Our objective is to recommend good quality, low cost plans that perform well.

Pension contribution limits

Many clients have been concerned about the higher levels of pension contributions that can be paid. In previous tax years, some were restricted to a total additional contribution of £20,000 per annum gross. This changed in the tax year 2011/2012 to a higher level of £50,000 per annum gross, inclusive of existing contributions (both employer and employee). From April 2014, this limit fell to £40,000 per annum gross in total. This level is still applicable to the tax years 2015/2016, 2016/2017 and 2017/2018. It is important to note that those who draw any income from their money purchase (defined contribution) pension arrangements may have found this limit restricted to £10,000 gross from all sources in the tax year 2016/2017 and to £4,000 gross in the current tax year 2017/2018.

Contribution limits for higher earners

It is also important to note that from the tax year 2016/2017 the standard maximum £40,000 gross pension contribution annual allowance is reduced by £1 for every £2 of adjusted income individuals receive who earn over £150,000 gross income in a tax year, until their pension annual allowance drops to £10,000 gross per annum from all sources. As an example, if an individual was to receive income of £210,000 gross in the tax year 2017/2018, they would see their pension annual allowance cut by £30,000 gross to £10,000 gross from all sources. The figure of £210,000 pa gross would include any employer pension contributions.

In addition, for those that want to go further with their pension contributions, it is also possible for pension scheme members to use a three year 'HMRC Carry Forward' facility to use up pension tax allowances from previous years (where available). As an example, this might be useful for those getting close to their planned retirement time. We recommend that you seek appropriate advice with regards to this.

What we will need to understand from you is the level of investment risk that you can accept to achieve growth in your plan taking into account the term that you have to retirement and the ways in which you may wish to draw income in retirement. You may want to consider this further and details of this can be found on our website here

We also believe that diversity of investment is important, 'all eggs in one basket' is often not the best answer. Having reviewed you circumstances and needs, recommendations can be made to optimise the accumulation in your plan. We would also be happy to liaise with your Accountant to improve your overall wealth management and tax position.

As always, you need to know that the value of your investment can go down as well as up and that past performance is not a guarantee of future performance.

My recommendation is that all clients (and those who should be funding for retirement!) should review their existing arrangements to ensure that they have made the most of the significant opportunities available to them in the current pension regime. This includes members of occupational pension schemes who really have scope to capitalise on their existing arrangements. Proactive management of your investments is key.

HMRC Lifetime Allowance

There is a "Lifetime Allowance" (LTA) for the maximum amount of all your tax favoured pension savings. The pension Lifetime Allowance (LTA) is currently £1.0M (tax year 2017/2018). This limit has already dropped from £1.80M (tax year 2011/2012) and £1.5M (tax year 2013/14) and fell further to £1.25M in the tax year 2015/2016 and £1M in 2016/2017. This could affect those in personal pension and occupational type schemes, including (as examples):

  • Those in active or deferred Defined Benefit (Final Salary) schemes
  • Those currently in Income Drawdown arrangements

You may want to look at this issue if you have, or are likely to accrue, final salary benefits of approximately £50,000 gross pa or, as a further example, approximately £42,500 pa plus three times cash.

If you are affected by these issues, you may want to seek individual financial advice on the benefits of HMRC Lifetime Allowance protection. Please note that it is no longer possible to apply for HMRC Individual Protection 2014 (IP2014 / IP14).

HMRC Pensions Fixed Protection 2016

If you plan to apply for Fixed Protection 2016 for your existing pension benefits, you can achieve this online via the Government Gateway: https://www.gov.uk/guidance/pension-schemes-protect-your-lifetime-allowance . HMRC Individual Protection 2016 is also now available via the same link for those with existing accrued benefits above £1.25M. The LTA has fallen to £1M from 06 April 2016.

To be eligible for this higher level of HMRC Protection, individuals will be required to have ceased contributions or active membership of any pension before 06 April 2016.

If you have applied for Fixed Protection or Individual Protection, you will need to be careful about the effects of your employer enrolling you in any Auto-Enrolment Scheme that may be required of them.

Drawing Pension Benefits

Pension benefits can be taken at any time from age 55 and, as of April 2011, you will no longer need to purchase an annuity under the legislation introduced by the coalition Government. You do not have to retire to take the tax free cash (if available) or taxable income. From the tax year 2010, the minimum pension age has been increased to 55 from 50 (unless ill-health early retirement is permitted). This is intended to increase still further to age 57 by 2028.

As noted above, these significant pension benefit changes came into force from 06 April 2015

With this in mind, the 'headlines' that should be considered by each client before they make any important decisions are as follows:

  • Normally 25% of any unvested pension fund can be drawn as tax free cash.
  • No restriction on income levels that you can draw from your plan.
  • Income can be phased to meet your needs.
  • Any income taken is still subject to income tax. You should be mindful of higher rate income tax charges if you take significant sums from your plan.
  • Under the new legislation, there is now no tax charge on your pension fund on your death before the age of 75.
  • Benefits available to estates for those over 75 will be taxed at the recipient's highest marginal income tax rate, whether taken as a lump sum or as a regular income.

You will be able to draw your pension and carry on working. This allows individuals to take their benefits while continuing to work, for example part time, as they move more gradually to retirement. You may want to think about any effects on your income tax if this is the case and the combination of earned income and pension income may increase your overall tax liability.

There is no limit on the pension income in retirement that can be taken. The pension benefits that you will receive from your personal pension depend on the amount of money finally available. In my view, taking financial planning advice has never been so important for retirees and potential retirees in this climate. Starting the advice process early is vital, years in advance, to ensure that retirement is as comfortable as was anticipated when the client first started saving all those years ago.

So why start planning so early? In my view, this is because of the many options that are available for retirement benefits and that fact that each client is different, with different expectations, anticipations and assets available to meet these requirements.

Taking this a stage further, we need to consider what options are available for retirement income and I have listed some examples below:

  • Defer retirement until later.
  • State pension benefits.
  • Need for tax free cash.
  • Buying annuity benefits, taking into account the client's requirements and circumstances, such as health, smoker status, spouse's benefit, tax position and protection against inflation.
  • Phased retirement, including short term annuities.
  • Income Drawdown.

Deferring retirement, State Pension & need for tax free cash

Deferring taking pension benefits is an option at this time, especially for those who may not have planned to take pension benefits now. These may include those being made redundant at a later stage in their working career. Dependent on the circumstances, using other savings (or a redundancy payment) to subsidise income in the shorter term may be a real option if the pension fund value has fallen and needs to recover. However, a cautionary note needs to be added here. The minimum retirement age has increased to 55 from 2010. To reiterate, it is the advice at this stage after careful consideration of the situation that will guide a client appropriately. If someone continues to work past their State Pension age, they can also defer their State Pension. The advantage of this is that the State Pension increases by 1% for every 5 weeks deferred. This amounts to about 10.4% for a full year and this can be valuable in the right situation. From early April 2016, this increase has been reduced to 5.8% pa for those eligible for state pension benefits after this time.

The change to the State Pension to a new flat rate (£159.55 per week / full rate (2017/2018)) applies for those retiring after 06 April 2016 and is called the New State Pension. Those already in receipt of the old basic State Pension will continue to receive their previous level of benefits, up to the maximum of £122.30 per week (2017/2018). This income is paid gross, but is taxable. Other state pension benefits, such as the Graduated Pension and the State Earning Related Pension (SERPS) may be paid in addition to the standard basic State Pension. You can check what you may be entitled to here: https://www.gov.uk/state-pension-statement

As always, advice should be sought on this issue before taking pension benefits.

In an ideal world, I would like to see a client enter retirement debt free and with 3-6 months' income on easily accessible deposit in case of an emergency. This may not always be possible, but the ability to take tax free cash at the time retirement benefits are drawn may be used for this issue. Tax free cash can now also be taken from funds accumulated by Protected Rights or Safeguarded Rights, which are Protected Rights transferred under a (divorce) pension sharing order. Therefore, care needs to be taken, especially if the benefits are being drawn from a final salary scheme or policy with a guaranteed annuity rate, as the cash gained may result in the loss of an annuity rate that cannot be replicated elsewhere.

Your Retirement Benefit Options

You can choose the type of income/benefit you take. This could be:

  • To draw tax free cash and take the balance of the fund as cash (or a proportion of the fund), subject to your highest marginal income tax rate.
  • To draw the tax free cash and leave the remaining fund unchanged.
  • To purchase an annuity.
  • To phase your retirement by purchasing annuities/taking income on a year by year basis from segments of the overall fund while leaving the remaining fund invested.
  • To take income from the invested fund on a year by year basis ('Income Drawdown').
  • Combination of the above.

I have provided some thoughts on these options below.

Annuity Purchase

Historically, the most common way to take retirement benefits under pension plans was to take the maximum tax free cash sum available and use the balance of your fund to buy an annuity. An annuity is a level or increasing income for the rest of your life and is taxed in the same way as a salary.

An annuity gives you payments at stated intervals until your death. You give your pension fund either to the insurance company that you have built up your funds with or to another on the open market to purchase as large an income as possible for the rest of your life (sometimes called the Open Market Option/ OMO). There are a number of types of annuity, which include Guaranteed, Unit Linked, With Profits, Value-protected and Impaired Life Annuities.

Guarantees & Dependants' Pensions

The cheapest annuity you can buy, i.e. one that will give you the highest starting income in return for your pension fund, is one that pays a level income for the rest of your life. However, when you die, no further income is payable even if you die after receiving only a few income payments.

At a cost, you can add extra benefits to your annuity at the outset, and these can include a guaranteed period of say five years, which will ensure income payments continue for the fixed period after you buy the annuity, even if you die before then. You are also able to purchase an escalating annuity which will mean that your income increases in payment and may help keep pace with price increases and the effects of inflation.

Where married or in a partnership (or with a financial dependant), you may decide to build into the annuity a spouse's pension that will continue to be paid in the event of the annuitant's death. Typically, the pension will reduce by one half or one third if the annuitant predeceases their spouse.

Guaranteed Annuities simply purchase an income based on the annuitant's age, normal life expectancy and the level of Gilt yields (on which annuity rates are based). These guaranteed annuities can be improved upon for 'impaired lives', which are subject to medical evidence, because of reduced life expectancy, and this is an area where there could be an improvement in the basic annuity rate available at the time.

Investment Linked Annuities

Investment linked Annuities invest in unit-linked equity type funds or with profits funds and the levels of income received are linked to how well the investments perform. With good investment conditions, these annuities can produce an increasing level of income. If required, independent financial advice should be sought on these types of plan because of the investment risk involved.

Advantages of an Annuity

  • You have immediate access to all of your tax-free cash.
  • You can choose between a level or increasing income for life with the rest of your fund.
  • The income is guaranteed to be payable for at least the rest of your life (this does not apply to Investment Linked Annuities).
  • Your pension income can be guaranteed for a certain period so that payments will continue for a fixed period after your death.
  • Depending on how long you live you may get back more than you used to buy the annuity in the first place.
  • They are relatively simple plans and usually do not involve on-going planning.

Disadvantages of an Annuity

  • Annuity rates may not be favourable when you buy your annuity.
  • The levels of income and annuity features selected are fixed at the outset and cannot be changed even though your future income requirements, personal circumstances or health may change.
  • It is possible that you may not get back the amount of money you used to buy the annuity if you die early.
  • Options selected at outset, which come at a cost, may not be used in practice e.g. if you choose a spouse's pension option and your spouse predeceases you then the cost of this benefit has been lost.

Pension Income Drawdown Facility

By using this type of facility, you can initially take the tax free cash (again usually 25% of the fund) and the residual fund would be used to provide a taxable income, if you choose.

Historically, when you started an income drawdown contract, the maximum level of income was calculated. This was based on 15-year gilt yields and used a formula given by the Government Actuaries Department (or GAD rate as it is known). Most also provided a 'critical yield' calculation (the amount of return required to compete with an annuity purchase). These calculations are still valuable in demonstrating the growth needed to show how long value may be provided.

From April 2015, this annual withdrawal limit has been removed for defined contribution (money purchase) pension schemes. There is now no limit on the amount of income you can draw. The new legislation allows defined benefit (final salary) schemes to give this increased flexibility to individuals. However, this is not binding on defined benefit schemes and therefore an individual may have to transfer to a new personal arrangement to take advantage of the new, more flexible, rules. The real value of a defined benefit scheme is usually greater than that of a personal arrangement and this is a complex area in which professional financial advice must be sought.

Usually, I would not recommend that the maximum income is taken, as one of the risks associated with income drawdown is that if the underlying fund does not perform well and the plan charges are high, the future income could be lower than if an annuity were purchased now. If no income or minimum income is taken, there is a far greater opportunity for the fund to grow and it is likely that the resulting annuity will be higher, however, you would have to bear in mind that you have not enjoyed higher income in the previous years.

  • For those remaining in capped drawdown plans (i.e. income drawdown plans established before 06 April 2015 which have not been converted to flexible drawdown) the maximum and minimum income levels are currently recalculated every three years (annually for those aged over 75 and every five years for plans set up before 6 April 2011 until their first review date after 6 April 2011, when they will move to three year reviews). Income can be varied within this period as long as the maximum and minimum figures are not exceeded.
  • Any income provided will be taxed at your highest marginal income tax rate.

There are therefore risks involved in income drawdown.

  • The fund may not grow as hoped and this could lead to an eventual shortfall in income in later years.
  • Annuity rates may fall further in the future and the annuity that is eventually purchased could be lower than if one were purchased now.
  • If maximum income is required, this route may well not be the most appropriate as the growth needed to maintain this income level could prove difficult to achieve. Normally to allow for realistic growth rates, you should be considering income in the region of 4-5.0% pa of the fund.
  • A potential benefit of purchasing an annuity versus using income drawdown is the cross-subsidy from those annuitants dying early to those that live longer. Mortality drag is the extra return that needs to be earned on investments within the drawdown contract to provide the same level of income as an annuity, as a result of this lack of cross subsidy.

Death Benefits

One of the main attractions that income drawdown may have is the superior death benefits.

If you buy an annuity, then it is simply on your life/ joint lives and there would usually be no return at all to your estate on your death beyond the guaranteed period that might be written into the contract. With Income Drawdown, the residual fund is available.

If you die before the age of 75 whilst taking Income Drawdown, or if the fund is uncrystallised (all still invested), your dependants will be able to receive the value of the remaining fund tax free.

The person receiving the pension will pay no tax on the money they withdraw from that pension, whether it is taken as a single lump sum or accessed through Income Drawdown. If you die over the age of 75 whilst taking Income Drawdown, or with uncrystallised pension funds, the beneficiary will be able to access the pension funds flexibly, at any age, and pay tax at their marginal rate of income tax.

Pension drawdown therefore gives you and your dependants far more flexibility in making use of the pension funds. However, this is given at a price and the price is that you lose the guarantee that is provided by a conventional annuity.

If you chose this option, I would recommend that in the event of your death your fund should be nominated to financial dependants. This nomination can be updated if needed in the future.

Inheritance Tax

By concession, HMRC would not normally impose inheritance tax on any death.

HMRC / Occurrence of death within 2 years of drawing pension benefits/ Possible additional tax charges

We are aware that HMRC currently maintain a policy of investigating any pension transfers/withdrawals that occur within 2 years prior to death. HMRC will seek to ensure that the implemented transaction was not arranged to avoid any tax on the pension benefits affected. If, in their view, the transaction was to avoid tax, they may seek to apply an inheritance tax charge to the benefits drawn at a level of a further 40%.

You should be aware of this current position before proceeding.

Summary

You can see from the above that planning to draw the benefits from your retirement plans can be a complicated subject. Therefore, this text should not be treated as individual advice. Individual advice is only available based on your personal circumstances. A useful summary /pdf of this document is attached here.

We are qualified to provide bespoke advice on all areas of retirement planning, both for private and occupational pension schemes. We would be pleased to guide you with the objective of achieving greater value either through better terms or reduced taxation. The text above is based on our current understanding of legislation which can change. Please check that the rules detailed above are correct before making any financial decisions and seek individual advice in your circumstances.

Chapters Financial Limited is not responsible for the content of external webpages.

Please note that this is for guidance only and that the information outlined in this document is not intended as personalised investment advice and may not be suitable for everyone. You should seek independent financial advice before proceeding further. The Financial Conduct Authority does not regulate taxation and trust advice.

Chapters Financial Limited is Authorised and Regulated by the Financial Conduct Authority.