Drawing your Pension

Conventional Annuities

With a conventional annuity, the funds available from your pension policies are used to purchase an annuity that would be payable throughout your lifetime. Advantages to conventional annuities are the fact that once the income has started, it is guaranteed for at least your own lifetime. You can also elect to include a spouses pension, payments can be guaranteed for a number of years (normally 5 or 10) and the income payable can be level, or on an increasing basis.

Potential disadvantages to conventional annuities are that once the type of annuity has been decided, (i.e. level or increasing, with or without spouse’s pensions and guarantee periods’ etc.), the basis cannot be altered at a later date. It is important to remember, if you select a level annuity, the income payable will not increase in the future, thus over the years inflation could reduce the purchasing power of your income.

Investment Linked & With Profit Annuities

Investment Linked and With-profit annuities link the value of your future pension income to the performance of a company’s specific managed fund or with-profit fund.

Both investment linked and with profit style annuity pension income has the potential to grow throughout retirement and so may provide some protection from the effects of inflation and they enable you to be free from being locked into low fixed annuity interest rates. At outset you choose a level of performance or income that you feel that the fund will achieve each year and the level of growth you have anticipated is used to establish the starting income. Your income is then reviewed regularly and may increase if the overall performance of a managed fund or bonuses declared in the with profits fund exceed the anticipated growth you expected.

However, conversely, if the growth has been lower than you anticipated your income could also decrease. Therefore, any growth in your annuity income will be linked directly to the investment performance of the specific managed funds or with profits fund chosen.

Managed funds invest mainly in company shares both in the UK and overseas and performance is linked directly to the value of the shares within the fund and the value of such funds can fall as well as rise.

With Profit Funds invest mainly in company shares, fixed interest securities and commercial property but aim to smooth out the peaks and troughs of the underlying investments. What makes With Profit funds so attractive is the way your money grows. Every year the company will assess it’s profitability, investment returns, and what it thinks the future holds. If after taking into account these factors, things look favourable, the company will announce a bonus rate (known as an annual or reversionary bonus). In addition, to make sure that you receive your share of the growth achieved from the with profits fund over the period that you have been invested a terminal bonus may also be payable. Although terminal bonuses are not guaranteed.

With Profits funds therefore have the advantage that if equity markets experience a sharp fall, your income is unlikely to suffer immediately.

Historically both the fund types described above have produced better performance than fixed interest assets over the medium to long-term, however this is no guide to future returns.

Value Protection

It is possible to add value protection to either of the above options. This means that in the event of the death of the annuitant (or second death where a spouse’s pension is included), a lump sum could be paid to the estate equal to the amount of money used to purchase the annuity less the gross income paid. This is subject to a 35% tax charge.

You do not have to protect all of the annuity purchase price, you can select an amount to protect.

Income Drawdown (Unsecured Pension)

This type of plan facilitates an income to be drawn from a pension fund and the tax free cash lump sum to be taken, without immediately purchasing an annuity.

An annuity can be purchased at any time and, under existing rules unsecured pension can only continue until age 77 when you will have other options that we would discuss at the time. There are several advantages of using such a plan.

Firstly, subject to limits imposed by legislation, you are able to plan in advance the level of income that you wish to take each year, to adapt to changes in your personal financial circumstances. The value of your pension fund will continue to be invested until you decide to purchase your annuity. Depending upon investment returns, this may provide you with the opportunity to achieve sufficient growth to improve your benefits. In addition, this type of policy can be useful when trying to mitigate both income tax and inheritance tax, by using varying levels of income. If the member of the pension scheme dies within two years of beginning income withdrawal the fund value paid may still be added to the value of your estate for calculation of IHT.

You can defer the purchase of an annuity in the hope that annuity rates will rise, although there is no guarantee that this will happen.

Finally, death benefits provided by this type of plan can be both higher and more flexible than that available from a conventional annuity. However, a 35% tax charge will apply to any lump sum death benefits payable from a pension fund withdrawal plan from which you have started to draw an income.

Despite the advantages of pension fund withdrawal plans, there are also drawbacks, which you need to be made aware of.

The main drawbacks are listed below and it is important that you read and understand the relevant information provided.

Firstly, there is no guarantee that your income will be as high as that offered by the purchase of an annuity. Your benefits will be dependent upon the investment performance of the funds and the level of income you wish to draw. The value of your pension fund may go down as well as up and is not usually guaranteed. In addition, there is no guarantee that annuity rates will improve in the future. They may be lower when you decide to purchase an annuity than they are currently.

Annuity rates include an element of return arising from the fact that some individuals who have purchased an annuity will die sooner than is expected. By delaying the purchase of your annuity, the benefit of this potential return is lost.

Currently, the minimum and maximum income amounts are set by the Government Actuary Department and you can take an income between these two amounts. The minimum income is nil and the maximum is 120% of the prevailing single life annuity that could be purchased on a level basis. The maximum amount is reviewed every 5 years and you do not have to continue taking the income once it has commenced; it can cease at any time.

It is now possible to withdraw tax free cash up to 25% of the fund value without the need to use the balancing fund to provide a retirement income. The retirement income can be taken at a later date.

There will be other options available to you at age 77 as opposed to only having to use the fund to purchase an annuity and we will discuss these nearer the time as it may be that further changes are made between now and that time.

Short Term Annuity