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Can I withdraw money from my pension?

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We look at the different ways to take money from a pension, such as income drawdown and annuities

Sean Gilbert

Chartered Financial Planner

26th April 2023

This article will give a brief overview of the options available when accessing a pension fund. For a more in-depth overview, click here to download our guide to your retirement options.

You can usually start taking money from your pension plan once you reach age 55 (rising to 57 from 2028). Typically, individuals are permitted to withdraw up to 25% of their pension pot without incurring taxes, while the remaining amount is subject to income tax. The exact amount of income tax owed is determined by various factors, including your total income, personal circumstances, and location within the UK.

There are various options available for the remaining pension amount such as; Lifetime Annuity, Scheme Pension, Phased Retirement, Drawdown and UFPLS.

This article will focus on Lifetime Annuities and Drawdown.

Lifetime Annuity

Overview
An annuity is simply a series of payments made at selected intervals in return for a pension fund. The level of payment is dependent upon age, annuity rate, size of fund and options selected. Annuity rates tend to mirror interest rates since they are related to the returns earned on Fixed Interest Gilt Edge Securities.

Tax-Free Cash
Most types of pension plan have the option of taking a tax-free cash lump sum before exchanging the residual fund for a series of payments. Once an annuity has been purchased there is no further entitlement to tax-free cash, therefore the decision of whether to access the cash or not needs to be made at outset.

Income
Annuity payments are taxed at source under the PAYE system. Provided a P45 is presented the annuity will be paid net of your marginal rate of tax and there will be no further tax liability. Payments can be made monthly, quarterly, half yearly or yearly and can be in advance or arrears. Payments can remain level, can decrease or can increase e.g. at a set rate or in line with an index such as the Retail Prices Index.

Death benefits
The option of what type of death benefits to include must be made at outset. The options
available are as follows:-

  • A spouse’s or dependents pension up to 100% of the pension you had received
  • A lump sum

Protecting your annuity
There are ways of protecting your annuity if you’re worried about what will happen to it if you die soon after you retire.

Commonly known as Value Protection, this option can be included to ensure that on death), the original fund value, less the gross income payments already made, can be paid out. On death before age 75, this will be tax free. On death after age 75, this is taxed at the beneficiaries’ marginal rate of income tax.
Guarantee periods allow you to opt for your annuity to pay out for a specific number of years even if you die within this time. On your death the income may continue to be paid for the rest of the guarantee period. You should not look at a guarantee as an alternative to a joint-life annuity, because any income will stop at the end of the guarantee period, not when your spouse or partner dies.

You should note that where the value of the annuity on death is below £30,000 it may be possible for the remaining guaranteed payments to be paid as a lump sum.

Advantages

  • You will receive a guaranteed income for life, and you can elect for your spouse/beneficiaries to receive a guaranteed income or a lump sum less tax upon your death.
  • Tax-free cash is available at outset.
  • There are no additional charges applied to the contract once in force. All charges are taken at outset and are reflected in the annuity rate offered.
  • The contract is simple to understand, there is no need to review the contract and there is minimal paperwork needed to start the payment of benefits.

Disadvantages

  • There is no opportunity of participating in future investment returns.
  • The various options in relation to death benefits and increasing / decreasing income levels etc must be selected at outset and will result in a lower initial pension payment. These selected benefits cannot be altered in the future.

Suitability
Lifetime annuities are most likely to suit individuals who want an absolute guarantee on their pension payments and/or for their spouse/partner. They therefore suit individuals with low attitudes to risk and a requirement for security. They also suit individuals who have relatively small pension funds and who will be heavily reliant on their pension income.

Download our free guide to your retirement options

Drawdown Pension

Overview
There have been many different versions of Drawdown over the years:

For plans set up prior to 6th April 2015, the most common type was:

Capped Drawdown – An annual income can be taken from the invested pension fund, if required. This income may vary between limits, set at outset by the Government Actuary’s Department (GAD). The maximum limit is reviewed every 3 years up until age 75 and then annually thereafter. The figure is derived from tables published by the Government Actuaries Dept (GAD) and is based on your fund size, age and the current gilt yield. This maximum current limit is broadly equal to 150% of a single life annuity that you could have purchased at that point. There is no minimum limit.

For individuals who took out these plans prior to April 2015, they will continue to run as they are providing income is kept below the 150% of GAD rates. Where this is the case the £60,000 annual allowance (2023/2024) for new money purchase pension contributions will remain. For high earners (income in excess of £200,000) or for those who have already flexibly accessed other pension plans, the annual allowance may be lower.

However, if more income than the 150% limit is taken, the plan automatically ‘tips into’ Flexi-access Drawdown and will trigger the money purchase annual allowance. Once triggered, any future money purchase pension contributions will automatically be limited to a £10,000. You will also not be able to undertake any future carry forward payments into money purchase pension
schemes.

The policyholder can also request for the plan to be converted into a Flexi Access Drawdown if they wish.

From 6th April 2015

Flexi Access Drawdown – this operates in the same way as Capped Drawdown though there is no limit on the income taken. After you have taken your entitlement to the tax-free lump sum at outset (usually 25% of the policy value), you can choose to take as much or as little of the remaining pot as you wish and it will be added to any other income you have in that tax year to determine the income tax rate that will apply.

Please note that if you draw any income from this plan, your future money purchase pension contributions will be limited to a £10,000 maximum Annual Allowance.

If taking an income stream from a Flexi Access Drawdown plan, the policyholder must alert all scheme administrators (of active plans) that they have flexibly accessed benefits within a 91 day reporting window. Failure to do so will lead to HMRC fines. This responsibility lies with the policyholder.

Tax-Free Cash

Most types of pension plan have the option of taking a tax-free cash lump sum before exchanging the residual fund for a series of payments. Ordinarily up to 25% of the fund – subject to a lifetime cap of £268,275 – may be taken as tax-free cash, however if the pension funds are or were part of an Occupational Pension Scheme or the individual had applied for transitional protection, then the available tax free cash may be greater. Tax Free Cash must be taken at outset and once drawn; there will be no further entitlement.

Income

A pension income does not have to be taken from the Flexi Access or Capped Drawdown options but if this is required, income is taxed as earned income under the PAYE system.

Death benefits

On death pre 75 the funds remaining in the plan will be paid out tax-free whether they are paid as beneficiary’s lump sum or an income.

Those aged 75 and over who haven’t yet started their pension, or are taking a drawdown pension will be able to pass on their remaining benefits to any beneficiary who will then be able to take it as a beneficiary’s drawdown pension or beneficiary’s annuity or as a lump sum taxed at their marginal rate of income tax.

Advantages

  •  You are able to take all of your tax-free cash lump sum entitlement at outset.
  • You do not receive a set income but are able to vary it to suit your personal circumstances, to supplement other sources of income or you have the option of taking it all at outset.
  • You are able to mitigate your liability to personal income tax in certain years.
  • You have the potential to benefit from good investment performance in a tax-efficient environment and to exercise control over your own investment portfolio.
  • There are flexible death benefits

Disadvantages

  •  You may run out of money and have no pension left.
  • Benefits are means tested by the DWP.
  • High-income withdrawals may not be sustainable during the deferral period
  • Taking large withdrawals may erode the capital value of the fund, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income when the annuity is eventually purchased and could also affect the long-term financial security of your spouse/partner.
  • The investment returns may be less than those shown in the illustrations.
  • Annuity rates may be at a worse level when annuity purchase takes place. Although annuity rates generally increase with age, they have fallen dramatically during the past 15 years with only a small increase more recently. This trend may continue.
  • A careful investment portfolio needs to be constructed which will involve some investment risk. This means the fund value could fall which could affect your future income levels.
  • Withdrawing too much income in the early years may have an adverse effect on preserving your pension purchasing power or preserving the capital value of your fund.
  • Increased flexibility brings increased costs and the need to review arrangements on an on-going basis.
  • There is no guarantee that your future income will be as high as that offered by an annuity purchased today.
  • You may feel the prospect of a future higher income does not compensate for the known income available from an annuity now and for the rest of your life.
  • The Financial Conduct Authority (FCA) has particular concerns in relation to mortality risk. If you purchase an annuity, you may benefit from a cross-subsidy from those annuitants that die relatively early. This cross-subsidy is not present with Drawdown Pensions and so to provide a comparable income, a higher investment return will be required. The impact of mortality can be expressed as an annual percentage rate by which the net investment performance of the remaining personal pension fund would have to exceed the interest rate implicit in an annuity in order to break even. This effect has become known as the ‘mortality drag’.
  • The charges are explicit whereas under an annuity they are inherent in the annuity rate offered.

Inheritance Tax Issues

The Government has confirmed that IHT will not typically apply to death benefits from pension schemes. They will however, be monitoring this issue so that pension schemes do not become a vehicle solely for IHT avoidance.

Suitability

Both Capped and Flexi-access Drawdown would be generally suited to the relatively sophisticated investor, who is capable of fully understanding the risks involved. The contract can be used as a useful tax planning tool and a means of accessing pension fund tax-free cash without having to take the full taxable income.

Download our free guide to your retirement options

Summary

This article has given a brief overview of annuities and income drawdown and their respective advantages and disadvantages.

When accessing your pension, you’ll be making decisions that will affect not only the rest of your life but also any funds left behind for your family.

This is an increasingly complex area and as such we would always recommend you seek financial advice before making any decisions.

This information is based on our current understanding and is subject to change without notice. This article is for general information only and does not constitute advice.  Whilst information is considered to be true and correct at the date of publication, changes in circumstances, regulation and legislation after the time of publication may impact on the accuracy of the article.

The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested.

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.

We have local offices in Edinburgh, Falkirk, Glasgow, Livingston and Stirling and provide Financial Advice throughout Scotland. If you would like to speak to an Independent Financial Adviser (IFA) then book your free initial consultation.

Sean Gilbert

Chartered Financial Planner

Chartered Financial Planner at Select Wealth Managers with 14 years of Financial Services experience. Before working in Financial Services, Sean…

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