Last week I covered three of the options you have with your pension pot at retirement: taking an annuity, retiring later and flexible access drawdown (leaving your fund invested and taking percentage withdrawals as and when needed).
The remaining three I’ll cover now are: the option of taking the whole pension pot, taking regular lump sum withdrawals and finally a combination of all the options mentioned over the two weeks.
While this will be slightly heavy, I can’t lighten it as it’s the detail which creates your financial security.
You have the option to withdraw your entire pension pot as a lump sum. The first 25% is usually tax-free (subject to maximums), while the remaining 75% is subject to income tax.
The upsides to you are that you have the flexibility with all that money to do with whatever you wish. The downsides are that you will most likely be pushed into a much higher tax bracket and you will lose quite a chunk of your pot to tax. Of course, you will also lose out on future tax-free growth on the pension, and any inheritance tax breaks, as the capital will now be in your ‘inheritance taxable’ estate.
Taking the pension as regular lump sum withdrawals is a further option. You can withdraw lump sums from your pension pot as needed. The first 25% of each withdrawal is tax-free, with the remaining amount subject to income tax. This allows you to decide which withdrawals you want now, and the amount i.e. to repay debts, a mortgage or a nice holiday.
You can tailor the extra over the tax-free cash amount to tie in with your income tax requirements i.e. take a lump sum that uses your income tax allowance over and above your tax free cash, so you might have the tax free cash allowance plus the extra as tax free if it was within your income tax allowance.
Naturally if you take too big an amount, that can push you into higher tax brackets.
At a later point, you can buy an annuity with the remaining funds you have invested if you wish.
Death benefits: With your remaining pension, if you die with funds still in your pension pot (not yet withdrawn) the treatment is similar to flexible access drawdown from last week in that if you die before the age of 75, the remaining pension pot can be passed on tax-free as per drawdown, but, obviously benefits already taken are part of the estate for inheritance tax. This process can continue, allowing the pension fund to potentially be passed down through several generations.
After the age of 75, the pot is subject to income tax at the new beneficiary’s marginal rate, but death benefits are as flexible drawdown and you can still nominate anyone to inherit your remaining pension pot, offering flexibility in passing on wealth.
And finally, you could consider a combination of all I have covered over the last two weeks. For example, a combination of the above options allows you to create a tailored retirement income strategy - you could use part of your pension pot to purchase an annuity for guaranteed income, keep some in drawdown for flexibility, and leave a portion invested for growth.
With that you can achieve a mix of guaranteed income, flexibility and growth potential and it allows you to structure your retirement income in a way which best suits your lifestyle and financial goals and taxable income.
With that flexibility comes more complexity, but that’s what you pay your independent financial adviser for.
The combination approach allows individuals looking to balance security and flexibility as well as tax planning ensuring they have both a guaranteed income and the potential for growth.
Retirement is a major life event which requires careful consideration and planning. Understanding the options available for accessing your pension is essential to making the right choice for your financial future. Each option has its own set of benefits and drawbacks and the best choice depends on your personal circumstances, financial goals, and risk tolerance.
- Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a retirement question, call Darren McKeever on 028 6863 2692.
