Retirement income options
May 2006
If you are due to retire shortly, you should be among the first to benefit from the new rules for pension income benefits introduced on 6 April 2006. So if you are a member of an executive pension plan, personal pension plan or retirement annuity, you have three main options (these are just for information and you should take independent advice before acting):
Purchase an annuity
Rates may be at historically low levels, but annuities should not be dismissed without careful thought. The traditional annuity has one very important advantage: it will give you a guaranteed gross income for as long as you live. While the alternatives can offer you potentially more income, they do not normally have any guarantees: your income could fall as well as rise.
If you choose a traditional annuity, you should never accept what your pension provider offers without first checking with us what annuity rates are available in the marketplace. The difference between the best and worst rates in the market can be substantial.
There are also now a small number of investment linked annuities. With these, you choose an assumed return for the investments underlying the annuity (between 0% and 5%) and this determines your initial level of income. Your subsequent income will depend on how the investments perform in relation to that assumed return.
If you are relatively cautious about how fast you think the underlying investments will grow in the future, you will start off with a low income, but with a higher probability that it will grow in the long term. But if you are reasonably optimistic in your assumptions, your initial income could be higher, with the possible danger that it will not increase and may even fall in the future.
Pension fund withdrawal
Your income is provided by making regular withdrawals from your pension fund (sometimes also called income drawdown or, under the new pension regime, unsecured income). The new tax rules mean that you are no longer required to buy an annuity by age 75 if you choose pension fund withdrawal. Instead you can continue withdrawals as unsecured income in the more restrictive form of an alternatively secured pension (ASP).
If you were to die before reaching the age of 75, the remaining withdrawal fund can generally be paid to your beneficiaries free of inheritance tax. If you opt for ASP at age 75, there are no lump sum death benefits, other than the option of a tax-free payment to your nominated charity. If you have dependants, in the first instance your remaining fund must be used to provide income benefits for them. If you have no dependants (or on their subsequent death) the residual fund can be transferred to the fund of another member of your pension scheme (eg a grandchild), but this would be liable to inheritance tax.
Phased retirement
If you do need your tax-free cash for a specific purpose, eg repaying loans, you could consider phased retirement. Under this option, each year (up until age 75 at the latest), you use part of your pension fund to provide:
• a tax-free lump sum, and
• either buy an annuity or take a pension fund withdrawal.
Your retirement ‘income’ is the combination of the lump sum and the taxable annuity or withdrawal payments. Normally this process means that there is little income tax liability in the early years, as most of your ‘income’ is actually tax-free cash. You should only consider phased retirement, pension fund withdrawals (including ASP) or investment linked annuities if you can afford to see your retirement income fluctuate. For example you might have another major source of income.
