Annuities or Drawdown - Which do I need
When it comes to making a decision on receiving an income from your pension the choices vary greatly and this is a decision that could affect the next 20-30 year of your life, so it is very important to get this correct.
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An annuity is when you pass the value of your pension to an insurance company and in return they agree to pay you a guaranteed income for the rest of your life, most commonly without any investment risk. These are possibly the simplest way to generate an income from your pension fund but care does need to be taken. Annuity rates are at an all-time low so you would be potentially locking yourself into a low income of which you cannot change. There are many different options to consider when it comes to annuities:-
Would you like an income which increases with inflation?
Would you like an income that would continue to your spouse if you were to pass away? And if so how much?
Would you like a guaranteed period?
The more of these options you add to your annuity, the lower your starting income will be. Any income you receive will be taxed at your highest tax rate.
Impaired Life Annuity
This is a type of annuity which may pay you a higher regular income due to ill-health. You may be a smoker, have a poor medical history or a shorter life expectancy.
It is the advisers’ responsibility to look into whether you could apply for an impaired annuity so you must be open with your medical history.
Open Market Option
Annuities are often offered by the same company that your pension fund is already with. Some pension plans have a guaranteed annuity rate and this could be better than what is on offer on the open market. An ‘Open Market Option’ is where the value of your fund will be put to a number of other providers to ensure a better rate cannot be obtained before you retire.
Clients with larger pension funds are tending to opt for a drawdown pension particularly as annuity rates are so low. A drawdown pension allows you to take an income from your pension while allowing the pension fund to stay invested in order that it may still continue to grow.
This works with the pension fund staying invested and thus is exposed to the ups and downs in the markets but allows you to take an income. This income is based on Government Actuary Department rates (GAD) and is called capped drawdown. This is a limit set by the Government about how much income can be taken from your pension. It is a complex calculation and is based on a number of factors but these rates and ultimately your income are reviewed every three or five years. Flei drawdown allows you to take any amout from your pension sudject to income tax at your marginal rate.
The advantage of a drawdown pension is that you can delay purchasing an annuity and your pension fund could increase if investment performance is good. The disadvantages are that if the investment performance is poor then your pension fund could reduce and with it your income.
This is an arrangement by way of using the 25% tax-free cash as income instead of a lump sum. This means that if your pension fund has a value of £100,000, then using £25,000 to give you an income in order to delay making a decision on the purchase of an annuity in the hope that the fund increases and/or the annuity increases.
With phased retirement and drawdown, you are dependent on investment growth, but this could fall and reduce your fund and future income. If you delay purchasing an annuity you may not receive as much income when you eventually decide to do so.
If you were to pass away, depending on which option you had chosen, it will affect the death benefit option.
If an annuity is purchased on a single life basis then there is no death benefit. If the annuity was purchased on a joint life basis then this income would continue until the demise of the second life. On the second death there is no further death benefit.
If you were to move into Drawdown or Phased Drawdown the death benefits vary depending on whether any benefits have been taken and the age of the individual on death.
If an individual was to pass away before age 75 then the pension could be taken as a lumps sum by any beneifary free of inheritance and income tax. Beneifaries do have the option to contiune in a drawdown pension however would pay income tax at their highest marginal rate.
If death occured after age 75 regardless of whether benefits have been taken or not, beneifaries can take income or lumps sums however this would be added to the beneifiaries income for tax purposes and taxed again at the highest marginal rate.
Any beneifary could then use an inherited pension fund to continue a drawdown arrangement at their drawdown rate or purchase an annuity.
It is now possible for any spouse, relitive or any unrealied 3rd party to inherite the proceeds of a drawdown pension.
Regardless of when death occurs it is possible for the inherited pension to remain inforce until the beneifary wishes to take benefits.
It is important to check what the death benefits are of any existing scheme compared to any proposed scheme.
Our team is on hand to advise you - call us on 01752 896943 to find out more.