Boost your income now
Simply Money Spring 2009
With investment markets depressed and interest rates at historically low levels, now may not seem like the time to be considering converting your pension pot into an income.
Some people may have little choice other than to access their pension fund because they are made redundant in their mid-to late 50s and have little prospect of getting another job. For others, it may be that ‘early’ retirement has always been a target and they are now within striking distance of achieving their goal.
Annuity rates are not particularly attractive at the moment. However, the option of using an accumulated retirement pot to generate an unsecured pension could well be of interest. One reason for this is that you can (provided you are over 50 now, or 55 from April 2010) take your 25% pension commencement lump sum (currently tax free) without purchasing an annuity—or even drawing an income from the balance of the fund.
This means that you can ‘have your cake and eat it’, receiving a lump sum but avoiding switching everything from equities into gilts (which are what back annuities) at a time when the FTSE100, in which many pension funds are invested, is over 35% below its long-term trend.
‘Drawdown’ in action
For example, with a pension fund worth £400,000, a 55 year old man might today expect to have a retirement income of as much as £38,000 a year, ignoring any tax free cash or widow’s benefits (source: www.sharingpensions.co.uk). This is, of course, taxable so the net figure could be in the region of £29,500 (based on the assumption that there are no other levels of income, so that basic rate tax only applies).
By taking a tax free lump sum of £30,000, the net income would be roughly the same and the pension fund would still be worth £370,000. Should markets recover, this would enable the investor to decide what to do next year, which could include, repeating the exercise, altering the amount taken or buying an annuity. (Of course the growth is unlikely be sufficient to ‘make up’ for the amount taken as a lump sum, so the eventual annuity would potentially be smaller.)
Death benefits
Once benefits are being taken, the way funds are treated on death changes. In this case, £120,000 worth of the fund will have been crystallised (that is, 4 times the amount taken as tax free cash). So, in the event of death, the uncrystallised part of the fund (£280,000, or £400,000 less £120,000) will be available for use to purchase a dependant’s annuity or returned to the estate. However, although the remaining £90,000 left in the fund (i.e. £120,000 less the £30,000 taken as cash, no income having been taken) could be used to provide a dependant’s income in the same way; should the money be returned to the estate as a lump sum there would be a 35% tax charge.
Age 75
At age 75, everything changes; it is no longer possible to take further tax free cash, and a minimum income must be drawn from the pension fund. In fact the additional tax on death may make this unattractive to those who do not have strong religious objections to annuitisation.
This approach many not be suitable for everyone and, as ever, you should take individual professional advice before making any decision relating to your personal finances. The value of investments is not guaranteed; you may get back less than you put in.
Key points
- Interest rates are low at the moment
- Using pension funds may be an option for some
- Death benefits are different once benefits are taken
