Typically a retiree can choose to take up to 25% of a pension fund as a tax free lump sum although some pension contracts may allow more or less than this depending on the scheme rules. Not taking the tax free lump sum would allow more of the funds to be used to secure a pension income but once the decision is made the option will not be available again.
Where a retiree has significant savings already, they may want to use the 25% to secure more pension income from an annuity. However, consideration should be given to their anticipated tax rate in retirement because a more tax efficient method of securing an income may be available through the purchase of a Purchased Life Annuity whereby most of the income is tax free.
Help on determining what personal allowance will be available in retirement can be found through the HMRC Website link to http://www.hmrc.gov.uk/rates/it.htm
When considering retirement options annuitants have to plan for what would happen in the event of death AFTER retirement. There are various options to choose from.
For those who don’t have any dependents or have dependents with significant independent
means, the option of No protection can be selected. This will mean more of the pension fund can be used to generate an income for the annuitant.
Spouse’s or dependents pension
In the event of death typically 33%, 50%, 66%, or 100% of pension annuity income will be paid to a nominated spouse or dependent for the remainder of their life. Choosing this option will decrease the annuitant’s income. There can be some restrictions on who can be nominated as some annuity companies will only allow a legal spouse or civil partner while others will also allow a dependent where proof of financial co-dependence can be provided.
On commencement of the pension annuity income, the guaranteed period is the time that the annuity will be paid in full, irrespective of whether the annuitant is alive. 0, 5 and 10 years can be chosen after which time the pension income will cease unless a spouses or dependents pension has also been selected and the spouse/dependent is still alive. Selecting a guaranteed period will reduce the annuitant’s income.
Value protection, when selected can protect up to 100% of the pension fund on death after retirement. The fund is returned in full less the income payments taken up to the date of death. In some cases a tax liability may apply where the fund is not used to provide a dependent with an income in their own name. If the beneficiary chooses to take the fund in cash a tax rate of 55% will apply. The addition of value protection is limited to certain providers and types of annuity.
How the income is received from an annuity can be tailored to the individual requirements of the annuitant. Income options include monthly, quarterly, half yearly and yearly advanced or in arrears.
Each option can have an effect on the overall income paid.
The sooner the annuity company has paid income the lower the income can be with annually in advance offering the lowest income while annually in arrears will pay the highest. However, consideration should be given to the Cost of Deferment as while taking income annually in arrears will offer the highest income, the annuitant will have to wait a year to be paid the first instalment of income.
Retirement options like Fixed Term Annuities and Income Drawdown will allow the retiree to take the tax free lump sum and chose to take zero income if required.
Unlike many final salary (defined benefit) work based pension schemes where income in retirement will increase each year through the retirees life, the majority of private and work based money purchase pension schemes require the purchase of an annuity at retirement to provide a pension income.
A retiree buying an annuity can select whether to have the income increase each year by 2%, 3%, 5% or by RPI (Retail Price Index) or CPI (Consumer Price Index).
The more the income increases each year will have a detrimental effect on the starting income.
The annuitant can also select to have a level or fixed income in retirement which will provide the highest initial income when benefits are started but will offer no protection against inflation.
A level pension income will lose its purchasing power through the retirees’ life because the income will not increase.
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