What will you do with your pension in retirement?
The world of pensions has literally been turned upside down and shaken all around by an announcement in the 2014 Budget: as of April 2015 you will be free to do whatever you like with your pension savings. No longer will you have to spend your hard-earned savings on an annuity.
This is great news if you are in the run-up to retirement - never before have so many options been open to you. But with this additional choice comes additional responsibility and you will need to think harder and plan more carefully to make sure you make the most of the money you have worked so hard to save.
The reason so many restrictions have existed historically is to ensure our money doesn't run out, so in making your choices now, you are going to have to take more care to ensure you don't spend your final days penniless and reliant on the state.
So what is changing?
The rules are being changed in a two-stage process. From April 2015 there will be total flexibility has to how you spend your pension savings, however interim changes were introduced shortly after the ground-breaking budget announcement providing increased flexibility for those retiring in the meantime.
The changes mean savers with small pensions will be able to take more as cash, freeing them from the need to buy an annuity that would literally only generate them a few pounds a week. Meanwhile, savers using income drawdown agreements will be able to increase the income they take while the entry restrictions for flexible drawdown – where you can draw as much or as little as you like from your pension – have been lowered.
Want to know more about the new rules? Click here
While this undoubtedly puts those who are retiring before April 2015 in a better position than they would have been prior to the budget, many will feel short-changed when comparing themselves with those retiring after this date.
For those retiring after 2015 - it is as yet unclear exactly how the new rules will work in practice. The government is currently consulting on the best way to proceed and details are expected later on in the summer. However we still have a enough information - including how pension cash will be taxed - for those in the run up to retirement to start thinking about how they will generate their pension income in light of the new rules.
Considering your options
Just because you have more options, it doesn't necessarily follow that you should use them. For many people, an annuity that pays a guaranteed income for life will still be the right option.
However those retirees who want to take more control over their savings or those who aren't so sure what the next 30-odd years will have in store, a more flexible income drawdown plan could have more appeal. Here your money is left invested – with the potential to carry on growing – and you simply draw down an income from that pot of money.
Other savers may be tempted to take more of their money as a lump sum to spend as they choose - be that to buy a property, invest in a business or simply go on a spending splurge. However one rule that hasn't changed is that you can only take 25% of your cash tax free - anything over and above this will be taxed, so in many cases this new flexibility may not be quite as attractive as it might initially have appeared.
If one thing is certain it is that retirement is no longer a predictable journey - some people will carry on working part-time once they're retired, others will set up new enterprises. Some people will be looking forward to a new life of leisure, while some will sadly be managing health problems. Each retiree will have their own set of needs and hopefully, the new pension regime will reflect that.
Mix and match
Invariably many people will mix and match the different options – but making the right calls for you, could be a tough choice. For this reason many more people will need to take independent financial advice to make sure they make the right decisions. For this reason the government has planned to make advice available to every retiree, but at this stage it remains unclear how this will work in practice.
If you think you'll benefit from advice it's better to get it sooner rather than later - don't leave it until you actually retire. Your retirement plans should have a significant impact on your investment strategy in the final years of work, so taking advice 10 years before you plan to hang up your boots could a be a very worthwhile investment.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.