With the implementation of pensions freedoms back in 2015, we now have more flexibility with regards to accessing our defined contribution retirement benefits than ever.
Flexibility is all well and good, but with change comes complexity. Let’s unpick your options at retirement – Flexi-Access Drawdown and Annuities – and weigh up each one.
Flexi-Access Drawdown
This is the newest-kid on the block when it comes to accessing your retirement benefits. Flexi-Access Drawdown, or FAD, is a relatively recent method of withdrawing pension income, which came into effect in 2015. Although this particular term is relatively new, various methods of drawdown have been available for many years prior to FAD. The main difference with this new version, is that- as the name suggests- it’s flexible.
What does that mean?
‘Drawdown’ is a commonly referred to method of providing retirement income. Increasing in popularity due to the pension freedom rules and the recent years of low annuity rates, drawdown is a very common method of extracting income from your retirement pot. It refers to the spending of retirement assets by simply dipping into those assets, whilst they (usually) remain invested.
What do you mean by flexible?
Older methods of drawdown often imposed limits, or restrictions on the amount of income you were allowed to withdraw from your pension. These rules were designed to try and stop you spending too quickly. Now, the restrictions have been removed and you can dip into your pension assets as and when you so wish*.
Pros:
- You are able to continue to benefit from investment growth during retirement, whilst you spend some of the money. It may even be possible to generate growth in excess of your withdrawals, allowing for some capital appreciation in addition to your income.
- This method is tax efficient- whilst the money remains in your pension pot, it grows tax-free. It also remains outside your estate for Inheritance Tax purposes.
- Death benefits. When you pass away, any money left in the ‘pot’ can be left to your beneficiaries. If you died when you were under 75, this will pass to them tax-free. If you survive beyond 75, it will be taxable at the beneficiary’s marginal rate.
- Flexibility. To state the obvious, you can flex the level of withdrawals to suit your needs. This can be particularly useful for income tax planning. Additionally, you have the flexibility to purchase an annuity in future years, should your needs change.
Cons:
- Naturally, investing carries risks; you can never guarantee a certain investment return or indeed, that the value of your pot will go up. However, you can help matters by ensuring that the income you draw is sustainable. This means the level of income is unlikely to erode your pension pot and in fact, your capital is more likely to be maintained over the longer term.
- You will need to receive ongoing advice, and often financial advice costs, throughout retirement. Something to be factored in when planning the retirement lifestyle you want!
- Complexity and uncertainty. This is not the most secure option. It isn’t simple and requires ongoing re-evaluation and maintenance. It’s highly likely that, at times, your pension value will be impacted by external factors therefore it’s crucial that you can accept the lack of certainty of any plans you make.
Remember to seek financial advice if you are in any doubt about the suitability of your withdrawals.
Annuities
An annuity is as far from FAD as you can get. You hand over your pension pot to an annuity provider who will, in turn, provide you with an income for the rest of your life. The provider will take into account your age and health, alongside any features you would like to include such as a dependent’s pension or indexation, before calculating the income they are prepared to pay you every year.
In recent years, annuities have become less popular due to the very low interest rate environment in which we live. As annuity rates rely on interest rates, the income levels available have been lower in recent years than they have been historically.
Pros
- Certainty. This is like a permanent salary for the rest of your life. It is fixed irrespective of what goes on in the investment markets, bringing financial peace of mind to your retirement.
- Simplicity. Once it’s set up, you don’t need to do anything else. It’s completely low-maintenance.
- Ill health enhancement. If you are in ill health, you may be entitled to an enhanced level of income.
Cons
- Perceived lack of value. Many people coming to retire now, will remember times of high interest rates. Locking into an annuity now could feel like a ‘bad deal’ as annuity rates historically have been much higher.
- Inflexibility. Once you select this option, you can’t make changes to it down the line.
- Potentially inferior death benefits. Unless you have selected this as a feature, there is no residual capital to leave to your family on death. The annuity stops when you pass away. If you have built in protection against this (for example with a guaranteed payment period) this will often reduce the amount of income payable to you whilst you are alive.
So, there we have it: All the complexity of accessing retirement benefits has been condensed down into 2 avenues: Certainty and security of income, versus trying to stretch the most out of your capital and flexibility.
If you wish to discuss the contents of this blog post please contact corryn.wild@three-counties.co.uk or telephone the office on 0191 230 3034.
Disclaimer: The above content does not constitute financial advice. Your circumstances may differ from those outlined and you should seek advice which is relevant to your own situation.
