What are the various options for accessing a pension pot?
If the time has come for you to access your retirement savings, then the good news is that there are a number of different ways in which you can do this. You certainly have a lot more flexibility in this respect than was the case, say, ten years ago.
Alongside the freedom to access your pension in different ways comes the need to make a decision as to which options to choose, but hopefully you won’t find the choice too daunting, especially if you seek assistance from a professional financial adviser.
An annuity is the traditional method of receiving benefits from your pension pot. However, there is no longer an obligation to purchase an annuity, and as we shall see, other options are available.
Annuities are very much still available though, although their popularity has declined in recent years, as other options became available, and as life expectancies increased. Annuities still pay a fixed income for life, regardless of how long you live for, but with the typical retirement lasting longer as people live to advanced ages, the annual income you might expect from the same level of pension savings has obviously reduced accordingly.
Nevertheless, some people still welcome the security of knowing that a guaranteed income will be paid for the rest of their life. None of the other options we will look at can offer this, and all of the other options require you, to some extent, to estimate how long your retirement might last.
Lump sum and income withdrawals
One of the major changes introduced in 2015’s ‘pension freedoms’ was to allow UK retirees to make ad-hoc withdrawals of any size from their pension pots, once they had reached age 55. These are known as Uncrystallised Funds Pension Lump Sums (UFPLS).
Because you are allowed to make a withdrawal of any size from a pension held in the UK, this means it is possible to withdraw the entire pot in one go, indeed Financial Conduct Authority data shows that this was easily the most popular way of accessing retirement savings in 2019/20, with 55.7% of pension pots being accessed in this way. However, it must be said that 90% of these pots were valued at £30,000 or less, so there’s little evidence that UK pensioners are wastefully spending large sums at once!
Unlike UFPLS, an income drawdown plan is a formal product with a financial provider. It allows you to withdraw some of your pension savings in order to provide you with an income, while the remainder of the fund remains invested, and hopefully, continues to grow. It’s possible to vary the income you receive at different stages of retirement, should you wish, but the more you take out, the more your pension pot is eroded and the less you will have for later in retirement. While the funds remain invested, you have the choice as to where these are invested – ideally they need to be invested in areas that match your risk profile.
If you purchase an annuity or enter into a drawdown arrangement and you have a UK-registered pension, you have the option of taking 25% of the fund as a lump sum, which will be paid free of tax.
If you opt to make ad-hoc lump sum withdrawals using the UFPLS option, then the first 25% of each withdrawal will be free of tax, while the remainder will be taxed as income.
If you withdraw all of your pension pot at once, again only 25% will be tax free and the remainder will be taxed as income.
How might all of this differ for expats?
If you are a UK citizen living abroad, you may still have a UK-registered pension arrangement, such as an International Self-Invested Personal Pension. In these circumstances, you should have full access to all of the UK’s pension freedoms.
If you are an expatriate and you don’t have a UK pension, then you may be able to get a larger slice of tax-free cash via a Qualifying Recognised Overseas Pension Scheme (QROPS). These pension arrangements, which are specifically designed for expatriates, normally allow you to take 30% of the fund as a tax-free lump sum, provided you have been resident outside the UK for five consecutive years by the time you access the plan.
Not every QROPS for expats will provide unlimited access to flexible drawdown or allow unlimited withdrawals. However, some QROPS will offer these facilities, and in any case, you should expect to have considerable flexibility as to how to access your retirement savings if you have a QROPS.
If you choose an annuity or a formal drawdown arrangement, then this doesn’t have to be with the same provider as your personal pension. You may be able to get significantly better returns by shopping around for the best provider.
This is a complex area and it’s a very good idea to seek professional financial advice.
One of the main reasons for saying this is that there could be significant adverse consequences from making large lump sum withdrawals. It might not be a good idea to transfer significant pension pots to low interest bank accounts, as some people might be doing. Furthermore, the authorities treat lump sum withdrawals as income for tax purposes, which could lead to the uninitiated being hit with very large, unexpected, tax bills!
Whether you are an expatriate or not, it’s also a good idea to seek financial advice because:
- There’s a wide range of different options available – annuities, drawdown etc.
- It’s much easier to shop around when you’ve engaged an independent financial adviser who has access to the whole of the market
- Some of the choices you make might be irreversible, such as purchasing an annuity, or making a large withdrawal
- Especially if you choose the drawdown option, you might need assistance with decisions on a regular basis, such as how large an income to take at each stage
- The volume of legislation and the jargon can get very confusing
If you would like to understand how you can best access your pensions contact us today for a free initial meeting. We are UK qualified Chartered Financial Planners, specialists in the area of pension planning, investment planning and IHT mitigation.