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Pension Fund Withdrawal
A tax free lump sum (Unsecured Pension)

Time will tell whether people will withdraw all their funds from the pension plans following the proposed budget changes. There have been some issues surrounding questionable investment returns; however the pension structure still offers a haven from income and capital gains tax. The real issue with pension for most people has been what happens when you die. Losing all the money that you have saved over your lifetime in your pension fund to either the annuity provider or government has been a major sticking point. Removing all your funds from your pension scheme may seem like a solution. However, this will simply add it to your estate which is potentially taxable at 40% on death. Therefore careful consideration will need to be given to all the changes once they pass the relevant government bills. In the meantime people still need to retire. Pension withdrawal at least leaves you with the option of taking advantage of future changes.

How does it work?

Your pension has been invested during your working life in a range of different assets. These may include equities, corporate bonds, Gilts, property and cash. The likelihood is that you would have had a higher exposure to the property and equity markets during your earlier working life to provide capital growth. As we age and retirement approaches, we tend to reduce the level of risk we are willing to take. Many pensions will automatically switch from equity into the less volatile corporate bond, Gilt and fixed income investments.

At retirement you are faced with a number of choices. The most common of these is to buy an annuity. Annuities will provide a guaranteed level of income [often fixed at retirement] with no chance of capital growth and limited death benefits.

A Pension Withdrawal plan [also known as income drawdown or unsecured pension] will allow a retiree to remain invested and take an income from the pension pot. Buying and annuity or taking Pension withdrawal is known as Pension Crystallisation. The level of Pension fund withdrawal income that can be taken from the Pension pot is based on 150% of the annuity you can buy with your pension fund. At this time you are able to take a tax free lump sum according to the rules of your pension plan.

  In drawdown, your pension investments need to be regularly reviewed to ensure that they are able to meet your future income needs. [Ideally at least annually] Every 5 years your adviser has to review your level of income in relation to your Pension withdrawal fund value. If the circumstances have been kind you may receive an increased income, if they have not you can see your income fall.

Income may be taken monthly, quarterly, annually or on an ad hoc basis. Many Drawdown funds sell units regularly in order to fund the income required. This can lead to capital erosion during volatile or down markets if the investments are sold at a lower value that they were bought for. Selling units or shares for income generation should only be considered if the value of the investment has risen.

Ear marked funds

We prefer to use an earmarked fund to provide an income. The earmarked fund is set up to provide between 3 and 5 years' worth of income without the need to sell equity based investments at a lower price. The earmarked fund is usually made up corporate bonds and Gilts that will mature in the next 3 -5 years, money market funds and cash. The income from the bonds, Gilt and dividends are used to top up the cash fund ready to pay the income. When market conditions allow we will sell equity to top up the earmarked fund to ensure a steady income without being forced to sell investments at a loss to provide income.

If you have read this far you obviously have an interest in retirement planning. Which leaves us with one more point on the new 'pension freedom', the money that you save during your working life still needs to last for your remaining days. It is this unknown factor in the whole pension equation that makes retirement income planning so difficult. Regardless of the new changes coming our way you need ensure that your savings last your lifetime.

 
 

Points to Consider
Pension Fund Withdrawal

 

Why might you consider Pension Fund Withdrawal?

• If you would like to take a large amount of tax free cash with little or no income from your pension fund. For example you may wish to repay the mortgage with your Tax free lump sum, but plan to work part time and have no need for income yet or wish to defer income to avoid higher rate taxes

• If you have alternative investments and or your pension fund is not your sole income source. You may just need a small top up to your income or an occasional lump sum. Drawdown would allow you funds to remain invested for growth.

If you have a younger partner or spouse. Drawdown would allow the remaining fund to be paid as a lump sum on death to your nominated person[s] subject to 55% tax charge .

• On death the whole fund could be passed to your Spouse/Civil partner, who could continue to take an income or buy an annuity with the fund [subject to their circumstances].

• You have considerable pension fund that you want to leave to your family [subject to 55% tax]

• You may wish to delay purchasing an annuity because you feel Annuity rates may rise or you feel that you are likely to get enhanced or impaired life annuity rates due to deterioration in heath in the future.

• Lastly if you are an experienced investor who would like to remain in control of your pension funds.

 

People considering Pension fund withdrawal should bear in mind that the greater in the income you draw that there is less chance of growing or maintaining the fund. This could affect its ability to buy an equivalent annuity in the future. The Drawbacks of Pension fund withdrawal should also be reviewed carefully.


Drawbacks of Pension Fund Withdrawal/Unsecured Pensions.

  • A Pension Fund withdrawal scheme is more complicated and is likely to be more costly than an Annuity
  • As the funds remain invested there are no guarantees that can be provided by an annuity, therefore any clients considering Pension fund withdrawal need to have some appetite for investment risk.
  • In order to maintain the capability of matching an annuity the Pension Withdrawal fund must be invested in relatively riskier investments than the annuity to pay the same level of income at a higher cost.
  • If only using Pension withdrawal to avoid what might be considered low annuity rates, one could find that annuity rates fall further.
  • Interruption to income if the funds need to be annuitized or transferred to another income provider
 
 
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