What can I do with my pension fund?

Every case is different as everybody has different financial circumstances. For some people their pension fund is their sole source of income in retirement, for others it is just part of the picture.

It is important to firstly think about where you can draw from in your retirement and this will help you to decide how secure you need to be with your pension funds. 

The main choice that you have with regard to pensions in retirement is to decide whether you wish to hand the risk over how long you live and how long the income payments need to be made to an insurance company by buying an annuity with all or some of your pension fund; or alternatively, just drawing on your pension funds to provide you with an annual income and perhaps a tax free cash lump sum at the outset. 

Annuities 

Generally if you have a fund at retirement which is less than £100,000 then an annuity may well be the safer option. The main risks you run with annuities are that:- 

• You do not live very long in retirement and you have handed over all your pension funds to the insurance company and therefore they make a large profit.

• You buy an annuity when the calculation to work out how much the insurance company can afford to give you each payment is at an historically low figure, an example of when this would be would be if interest rates were at historical lows.

• You do not buy add-ons such as a pension that increases by inflation and inflation is steep in your retirement years.

• You do not buy an added option of a spouse’s pension when your spouse outlives you for many years, potentially a more difficult situation as they have lost your income stream.

If before you buy an annuity though you think about these factors and are realistic about balancing what you need in retirement, and protecting those around you if they need protecting, then an annuity may well still be a good option. 

Many people are put off by the fact that they have to hand over their pension fund and effectively this is lost. If though you are of normal health and would expect to live a normal retirement then you may well benefit from an annuity. People who live an average or longer than average length of time benefit from effectively their pensions being topped up by those who have unfortunately passed away earlier than expected. The technical term for this is called mortality drag. So annuities are not all bad but are obviously not right for everybody. 

Unsecured Income (also known as Income Drawdown) 

If your pension fund is in excess of £100,000 then an alternative to look at would be unsecured income (previously known as income drawdown). With this type of contract quite simply you have the option to draw a quarter of your fund as a tax free cash lump sum and the remainder of your fund is invested and you draw out an income within a set limit each year.  

The limit will change as you get older as the payment is linked to your age and interest rates. This form of pension income is far more flexible and so you can tailor your income payments to meet your changing financial needs. 

For example if you part retire you may wish to start drawing on your pension but not take the maximum that is allowed until you are fully retired. This would mean that your pension fund would still continue to grow and may mean that you end up with a greater income later in retirement than you may have done if you had purchased an annuity.  

In order to work out the likelihood of this happening a financial adviser would need to provide you with a “critical yield”. This is effectively the rate by which your fund would need to grow to buy an annuity for you at certain ages; usually these are quoted at 65, 70 and 75. 

Unsecured income is a powerful tool which provides those who have had time and the inclination to make pension savings with the flexibility to be able to vary their income to their retirement needs. 

Obviously there are many other ways to invest for retirement, including using your existing investment to provide an income in retirement but obviously these come down to your own circumstances. 

Do you know how much your pensions are worth? Do you know how much you currently pay?Do you know how much your pensions cost you each month? 

All these will have an impact on what options you have when you come to retirement.

If you enjoyed this post, make sure you subscribe to my RSS feed!