One of your key financial planning priorities once you stop working will be to generate an income throughout retirement.
The amount you will need is liable to fluctuate during your retirement years, and will be driven by your personal priorities and circumstances.
The other key factor will be the amount of savings you have available, including the size of your pension fund, and other assets you can access to provide you with income.
This then raises the issue of how to draw the income you need.
You have full control over how you draw income from your pension fund
Pension Freedoms legislation, introduced in 2015, gives you an increased level of flexibility when it comes to drawing money from your pension fund.
Effectively there are just two rules governing when and how you can take money from your fund:
- You have to be age 55, rising to age 57 in 2028.
- You can only take 25% of your fund tax-free. Beyond that, you will pay Income Tax at your marginal rate on whatever you draw.
When it comes to structuring a regular income for yourself rather than simply taking lump sums on an ad hoc basis, there are two primary options:
- Taking drawdown income, while the remainder of your fund stays invested.
- Purchasing an annuity to provide yourself with a fixed income for life.
Read on to find out about the pros and cons of both those options, and some of the key issues you need to take into account when you are planning your retirement income.
Annuities provide you with guaranteed income for life
Annuities provide you with a regular, guaranteed income for life, regardless of how long you live or whether market fluctuations affect the underlying value of your fund. This gives you the peace of mind that you will not be left without any income.
Furthermore, you can structure your income to increase annually in line with inflation, as well as to provide an income for your spouse or partner should you predecease them.
Knowing that you have a secure income that can increase each year, regardless of any changes in your circumstances or financial markets, is valuable.
Additionally, recent changes in legislation mean that the value of your pension fund will form part of your estate when your Inheritance Tax (IHT) liability is being assessed on your death. However, the sum you use to buy an annuity will not be liable for IHT.
Tying up your money in an annuity reduces your flexibility
There are downsides to using some or all of your pension fund to provide yourself with an annuity income.
Effectively, you will be giving up income flexibility to provide yourself with income security.
This means that once your annuity is set up, it is not possible to change your income option, and you cannot cash in the policy.
You will also be missing out on potential investment growth on the funds you use to purchase your annuity.
Drawdown enables you to vary the income you take to match your needs
Compared to the rigid nature of annuities, income drawdown provides you with far more flexibility.
You can adjust the amount and frequency of the withdrawals from your fund and align your income with your retirement needs. As well as a regular income, you can also draw lump sums from your fund as and when you need them.
Importantly, the savings in your pension fund will remain invested, giving you the potential to enjoy continued investment growth throughout your retirement.
Your drawdown fund will remain subject to investment fluctuation
As you have been growing your pension fund during your working life, you will have benefited from long-term investment growth, potentially boosting the value of your fund.
However, once you have retired and are no longer earning a salary and contributing to your fund, your attitude to investment risk may change. Drawdown clearly involves such risk, and your pot could decrease in value, meaning you have less wealth to fund your retirement.
This means you will need to manage your investments and withdrawals after you have retired. Unsustainable withdrawals could mean that your fund may not last long enough to provide you with an income throughout your life.
As such, you will need to find the right balance to provide the income you need to fund your lifestyle without drawing too much.
Ultimately, the choice you make is not binary
In reality, the choice between drawdown and annuity is not an “either or” decision
Using both options could give you a mix of security and flexibility to suit your requirements and provide you with the income you need.
For example, you could use part of your pension pot to purchase an annuity for guaranteed income, and keep the rest invested in drawdown for potential long-term growth and income flexibility.
You can also make use of your tax-free cash sum to provide one-off lump sums, or as a tax-planning option to supplement your regular income.
Your willingness to accept investment risk and your income requirements are both likely to change as you get older. So, having both drawdown and annuity options available means that you can secure the regular income you need, while continuing to enjoy some investment growth.
Issues to consider when planning your retirement income
When it comes to retirement income, there is no such thing as a one-size-fits-all solution.
Having two differing options means you will be able to get the right mix of flexibility and security to suit your own needs.
When planning your retirement income, the questions you will need to consider include:
- How much investment risk are you prepared to accept?
- Do you need a guaranteed income to cover essential expenses?
- Do you have other sources of wealth you can use to provide yourself with an income?
By carefully considering your ongoing needs throughout retirement, you can create an income strategy that provides the right balance of flexibility and security.
Get in touch
If you would like to talk about your own retirement income arrangements, please get in touch with us at DBL Asset Management.
You can email enquiries@dbl-am.com or call 01625 529 499 to speak to us today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
The Financial Conduct Authority does not regulate estate planning.