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Pension options available in January 2015


All the latest personal pension information can be found on the Government website under planning for retirement. However, this practical example of a client aged 72, considering retirement before 75 and with a fund of £200,000 may help to illustrate some of the various options available.

The content of this article should not be taken as advice as your own circumstances may be different. All calculations and rates are accurate as at January 2015 and subject to change. Please contact us to arrange a meeting regarding your own personal financial affairs.

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Lump sum tax free cash

You can take 25% of your total pension fund as a tax free lump sum before your 75th birthday. The tax free sum can then be used for whatever purpose you wish and can be reinvested in a more accessible yet income producing vehicle such as a portfolio of ordinary shares, unit and investment trusts and gradually moved into the tax advantageous ISA environment. If you were to use Income Drawdown (see below) you could take the tax free cash now yet set the income at zero and allow your investments to continue to grow within your pension fund free of tax. Your pension fund value is around £200,000 so the tax free lump sum currently available is approximately £50,000.

The remaining portion of your pension fund can be used in two ways:

1. Annuity

You could purchase an annuity. There are various forms of annuity available, the most popular of which is fixed at a set amount for life and guaranteed to be paid for a minimum of five years even if you died within this time. This could be paid monthly, quarterly or annually. An annuity for a spouse, or anyone financially dependent on you, can be included – payable on your death. The annuity paid to you is treated as taxable income. Assuming you took the tax free cash lump sum of £50,000 the remaining fund could be used to purchase an annuity which at current rates would provide somewhere around £9,500 per annum. Althouth you are in good health and a non smoker, you should note that if this was not the case you might be eligble for an 'enhanced annuity' which often provides a higher level of annuity income.

The advantage of buying an annuity is that once purchased, you have the certainty of knowing exactly what you will receive as your gross pension income for the rest of your life.

However there are a number of disadvantages:

  • - Unless you purchase an index-linked annuity which increases annually, the value of the annuity will gradually be eroded by inflation. To index link your annuity to increase by 3% pa will mean reducing the starting annuity quoted above by almost a quarter.

  • - Once fixed, you cannot change the level or type of annuity.

  • - Depending on when you die, you may not get back the amount you paid for the annuity.

  • - If you die before your wife it is likely that the annuity she receives will be lower than the level you have previously enjoyed.

If you choose this option we can research the market for you to make sure you purchase an annuity from the company paying the highest rate. This is known as the Open Market Option. A separate modest fee would be charged by us that would reduce the annuity payable.

2. Flexi-access Drawdown

With this option you draw off an amount from your remaining pension fund after taking the tax free lump sum. From April 2015 you can set this figure at anything from zero to taking out the whole of the remaining pension. Any amount you draw out will be taxed at your marginal rate - probably 40% tax in the case of a large withdrawal payment. You can vary the amount you draw out each year.

As well as having a much more flexible approach the much greater advantage concerns the benefits available when you die. From April any remaining fund can be passed on to any beneficiaries. If you were to die before reaching the age of seventy five the fund can be passed on completely free of tax as a lump sum or to provide a future pension income to any beneficiary or beneficiaries you choose. Were you to die after 75 then there would be a 45% tax charge but this reduces from April 2016 to the beneficiary’s particular marginal rate of tax. The key point being that everything now revolves around your 75th birthday.

Although this is a much more flexible approach, Drawdown does have the disadvantage of exposing you to investment risk. Should the value of your investments fall in the medium or long-term then the value of your fund and the income available, or the annuity you could purchase at a later date, will be lower than today.

To make this option as efficient as possible it would be worth considering a Self Invested Personal Pension (SIPP). We would be able to advise you on the appropriate SIPP at the time you decided to go into Drawdown.

Options to consider now

  • - At some time before your 75th birthday you need to take out your tax free lump sum. There is no particular rush for this and it is whenever it would suit you best personally.

  • - If you should wish to access your tax free lump sum you will need to decide whether or not you are taking an annuity at the same time. If you do not want an annuity at that point we will need to look at transferring you to a pension plan which includes the maximum flexibility for drawdown.

  • - Lastly, it would be useful to consider the beneficiaries of your pension fund. The more flexible rules from April 2015 mean that non-dependents such as your children are now treated in the same way as your wife so you could consider making your children beneficiaries of part of your pension fund.

The content of this article should not be taken as advice as your own circumstances may be different. All calculations and rates are accurate as at January 2015 and subject to change. Please contact us to arrange a meeting regarding your own personal financial affairs.

#pension #annuity #retirement #tax

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