The options for taking pension benefits have changed in recent years. Taking out an annuity with your defined contribution pension pot was once compulsory, but nowadays it is just one option. We have detailed some of the basics on annuities in the UK here along with some considerations to help you decide if they are are the best way to meet your retirement needs.
An annuity is a product that provides guaranteed income and can be purchased with all or some of a pension pot. You can typically buy an annuity from your current pension provider, or you can purchase one from a different insurance company.
There are many different types available. The most common are various types of lifetime annuities, which guarantee income for every year as long as you live. Other annuities can be for a set number of years only. These can be useful if you need more money early on in your retirement, and may pay more than you would expect for a lifetime annuity.
Here are some details on some of the different type of annuities—you can check out the UK Government’s Pension Wise website to learn more.[i]
When you take out an annuity, the provider takes part or all of your pension pot and agrees to pay you a certain amount each year. This is known as the annuity rate. The figure depends on several factors. Some are financial and others are related to how long the insurance company expects to pay the annuity.
These factors include:
With so many factors involved, annuity rates offered can vary a lot. If you decide an annuity is right for you, it is worth shopping around—and talking to an adviser could help you make the right decision.
Depending on your circumstances, you may be able take up to a quarter (25%) of what is in your pension pot as a tax-free lump sum.* The tax-free amount doesn’t use up any of your Personal Allowance. You will only start paying tax when your income for the year exceeds that amount.
You can use all or part of the remaining portion of your pension pot in a variety of ways. If you choose an annuity, the income you receive from it is taxed like normal income. The exact figure will depend on your tax rate and your total income, taking into account any other money coming in.
Normally, individuals with defined-contribution pension schemes need to decide how to take their pension benefits—purchasing an annuity, keeping funds invested for income drawdown, or withdrawing as cash. If you have a defined-benefit pension scheme, you will already receive a guaranteed, secure income for life, with the amount increasing each year. A defined-benefit pension scheme pays an amount based on a number of factors, including the numbers of years you have worked for your employer and the salary you earned.
It is possible to take some of a defined-benefit pension as cash, or potentially transfer the scheme to a defined-contribution plan.[ii] However, there can be drawbacks to transferring out of a defined-benefit plan, no matter what option you are considering transferring into. That is why if the value of your defined-benefit pension is over £30,000, you are required to take advice from a regulated financial adviser before making a transfer.[iii]
If you are considering an annuity, you should be aware of some of the potential drawbacks. Here are some details on potential disadvantages:
You have a number of important decisions when it comes to pension pots and your retirement income. An annuity may not be the best decision for you, and it is far from your only choice. If you do choose an annuity, the variety of annuities to choose from can feel daunting.
Fisher Investments UK may be able to assist you with your retirement income planning. We have helped investors in the UK learn more about their investment choices, and to figure out the best fit for their retirement needs.
*This webpage should not be construed as tax advice. Please contact your tax professional if you have any questions.
[i] Source: UK Government Pension Wise website, as of 30/04/2019. https://www.pensionwise.gov.uk/en/guaranteed-income
[ii] Source: The Money Advice Service, as of 30/04/2019. https://www.moneyadviceservice.org.uk/en/articles/transferring-out-of-a-defined-benefit-pension-scheme
[iii] Source: The Pensions Advisory Service, as of 30/04/2019. https://www.pensionsadvisoryservice.org.uk/about-pensions/when-things-change/transferring-your-pension
[iv] Source: The Money Advice Service, as of 30/04/2019. https://www.moneyadviceservice.org.uk/en/articles/investment-linked-annuities
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