Choosing how to take our pension savings is likely to be one of the most difficult financial decisions we will ever have to face in our later life. This is why obtaining professional advice is so crucial when there is a need to make complex and irreversible decisions. Often these will also determine how we make our savings last and protect our funds from unpredictable factors, such as inflation and increasing life expectancy.

For most people, the choice will come down to striking a balance between minimising the risk to their capital and also retaining control over their funds. Individuals are no longer compelled to convert their benefits into an annuity but have a wide range of options, depending on what balance they wish to achieve.

The majority of pre-retirees still opt for the security of a conventional annuity, in which your pension fund is exchanged for a guaranteed regular income for life, regardless of stock market movements. Annuities still remain popular as increasing life expectancy puts added pressure on pension savings.

Annuities are based on the concept of a mortality cross-subsidy, so annuities provide valuable protection against outliving your assets. Once bought, an annuity cannot normally be changed, transferred or cashed in. Index-linked and with-profits annuities have in recent years introduced a greater flexibility to this issue, bringing with them a wider choice of death benefits and investment control.

An alternative to annuities are unsecured pensions (USP), or income drawdown. USP arrangements allow an individual to draw an income from their pension fund while the fund remains invested.

These funds are popular with people who have larger funds and other income streams and who require investment control over their benefits. The maximum level of income that can be drawn is approximately 120 per cent of the level lifetime annuity payable to a single person of your age and sex.

A lifetime annuity can be bought at any time, but by the age of 75 the remaining pension funds must be used either to purchase a lifetime annuity or enter into an Alternatively Secured Pension (ASP).

Aside from investment control, another attraction of a USP is that benefits can be passed on to heirs, minus a 35 per cent tax charge – although only until age 75, when you have to switch out of the USP.

Another option is phased retirement, or staggered vesting. This arrangement has been likened to taking lots of mini retirements, as it allows an individual to buy an annuity or go into drawdown in stages. You can use the tax-free cash each time you ‘mini retire’, as well as the annuity or USP, to provide income.

This can be a very useful tool for those wanting to ease back gradually on work and start to replace earnings with pension income. It also provides more flexible help for your survivors if you die before converting the whole of your fund to annuities.

A further option is an ASP. This arrangement works in a similar way to a USP in terms of investment flexibility but allows those aged 75 or over to bypass an annuity. However, measures in the previous Budget knocked this as a tax-planning tool, as any lump sum death benefits will be taxed at up to 70 per cent and could also be subject to inheritance tax.

>If you require any further information about the services that we provide or would like to review your financial planning position, please email or contact us.

Levels and bases of, and reliefs from, taxation are subject to change.
Article date: 08.07