Like everything in life, if we plan ahead then we can avoid problems and stresses later on. This could not be a truer statement than when applied to planning ahead for your retirement. Retirement is something that we should be able to look forward to. After all, after years of working hard 9 to 5, we all need some time to relax, slow down and enjoy our leisure time. However, we may have a whole bucket list of things that we want to do when we retire, but in order to do this, we will need money to survive. Having been used to a regular monthly income, it can be a bit of a shock to the system when all of a sudden the source of money coming in dries up. That is why you need to plan to replace it.
You may already have in mind a plan to provide the same level of earnings that you had before your retirement. For example, some people like to build up money in property portfolios and then cash in at the appropriate time. However, for most of us this income will come in the form of a pension. Don’t make the mistake of thinking that you can sort out your pension when you get older. You are never too young to start and the earlier you start to save into a suitable scheme, the bigger the pot of money you will have to draw from once you say goodbye to the days of working.
If you are reading this thinking that you should have done something about this a long time ago, but never got around to it, don’t panic. There are still solutions out there for you, so let us look at a few of them. As always, unless you know a tremendous amount about pensions, then do consult someone that does. Expert help and advice can save you a lot of money in the long run and no advice can leave you struggling once you hit retirement age. Financial advisers will be able to help you with finding the best pension fund to suit your purposes, changing your existing pension if you already have one and what to do once you decide to cash in on your pension.
So where do you start?
The easiest and simplest way to go forward is to look at what income you have at the moment along with your outgoings. You then need to remove from the calculations any payments that you are currently making which will not be relevant once you retire. You may no longer have to pay a mortgage, which should give you a huge monthly saving. Once you have these figures worked out, then you know roughly how much you need a month to live on. You then need to add on extras for social events, holidays, hobbies etc. and anything else that you have planned when you retire.
You can then start to look at the types of pensions that are available to you.
Qualifying for the state pension
The good thing about state pensions is that even if you have never put any cash into a private pension, you should still qualify to receive the state pension. This is totally dependent upon you having paid national insurance contributions whilst you were working. If you have paid in thirty years’ worth of contributions, then you should receive a full pension. Depending upon your age, you will eventually receive a letter from the Government Pensions Office giving you a forecast of your anticipated income upon retirement. If you want to find out prior to this then there are various forecasting tools online that can give you a rough idea of how much money to expect. Check out the www.gov.uk website for assistance.
Investigating Personal pensions
If you want to put some money into a personal pension, then there are plenty of options for you to look at so do your research carefully and if you feel out of your depth, please contact your financial advisor for assistance. The basics of a personal pension is that you pay in regular amounts, usually every month, and your contributions are invested in a fund of your choice for the length of the pension plan. You can choose how long you wish the pension to last for when you put it in place, usually tying it in with the year that you envisage taking retirement.
Pensions are a good way of investing as they are subject to tax relief. You also need to bear in mind that you cannot put into a pension plan each year more than you earn in a twelve month period.
What happens when your pension plan matures?
Once you hit that magical date when you decide to cash in on your personal pension plan, you have more decisions to make. Basically, you can take the monies that are in the fund either in the form of an annuity, which will give you a regular guaranteed income, or you can drawdown income from your pension a lump sum. So what is the difference between the two?
If you decide to go for the annuity option then your pension will give you a regular income, usually on a monthly or annual basis. In order to do this you need to purchase an annuity. Depending upon how much money you have within your pension fund to buy the annuity, you will be able to calculate how much money the pension will give you. Do bear in mind that once you have gone ahead with the annuity, you cannot back-track and change it or switch it. Making this choice is a one-time decision.
If you decide that you would like a regular income but to also keep your pension invested, this is then called drawdown. It is a more flexible option but does not give you the same level of security of income as the annuity plan will do.
What are the different types of annuity available?
There are in general two types of annuity plan that you can choose from:
- A pension annuity
- A purchase life annuity
No matter which option you decide to opt for, the annuity will provide you with:
- A secure assured income
- A steady stream of money coming in on a regular basis
- Money to live off for the whole of your life
- An income that ceases upon your death, unless you have gone down the route of a joint life annuity (for your partner or husband/wife) or a guaranteed period of payment or even a value protected annuity.
Why might you choose the annuity option?
Many people opt for the annuity plan as it provides you with peace of mind knowing that you will be in receipt of an income for as long as you live. Once you have made the decision that this is the way in which you wish to proceed, you need to do all that you can to get the best rate that you can for your pension fund to give a suitable annuity. Your financial advisor may suggest that you go for an open-market rate on your annuity, which means that you can shop around and get the best deal for your money.
What other decisions do you have to make about your annuity?
There are several other components of the annuity plan that you need to think about before you make the final choice:
- Do you want an annuity plan that will stop when you die, or continue to pay out to a partner?
- If you want your partner to be included, how much of the annuity plan do you want to allocate to them? i.e. 50% or more.
- Do you need a guarantee period to be applied? This allows you to leave your partner with an income for a set period of time i.e. 5 years, ten years.
- Will it suit you to have your annuity protected? If so, you can opt for something called an Annuity Protection Lump Sum Death Benefit. As an example, if your total annuity is worth £50,000 and you have received £20,000 and then die, the remaining sum of £30,000 would be paid to your estate after tax.
- Do you need an annuity that will increase over time? This is referred to as an Escalating Annuity and you can decide what percentage increase you would like to add on each year.
- Are you eligible for an Enhanced Annuity? If your health is not too good then you may be able to take a higher income , based upon the fact that your lifespan may be shortened. You can choose from a Lifestyle Annuity or an Impaired Life Annuity.
- If someone is terminally ill then they can choose an Immediate Needs annuity. This pays out a larger sum over just a short period of time.
- Do you want your annuity to be With Profits? If so, your pension fund will be invested in a fund that will give profits rather than just a fixed income. When choosing this option, do bear in mind that your money could go up, or down so it is a more risky decision.
- Are you looking for a flexible annuity which will give you an income but with the ability to make changes to the money you receive on a regular basis, how you invest the fund and the extent of the death benefits?
More information on the Drawdown option
If you decide not to go down the Annuity route, but to go for the Drawdown option instead, what does this involve? Basically, rather than purchase an Annuity with your pension fund, you take the income from the fund as it is as soon as you reach a specified age. The Drawdown option will give you:
- Total flexibility over the amount of income you take from the fund and how often you receive it.
- You can also vary the amount of the payments and the frequency.
What rules apply to taking a Drawdown on your pension?
If your choice is to go with the Drawdown option, then the following rules come into play:
- You have to be 55 years old
- You can continue to work
- The entire pension fund does not have to go into the Drawdown pot
- If you wish you can split your pension fund between Annuity and Drawdown
- Should you decide to go down the Drawdown route, you can switch to an Annuity later if you wish
- The drawdown can last as long as you want. It does not have to go into an Annuity
- When you put your funds into Drawdown you will also be allowed to take a tax-free lump sum of up to 25% and then your income will come from the balance that is left i.e. 75% which will be taxed.
There are then several options that relate to the Drawdowns on your pensions:
Capped Drawdown – this restricts how much income you can take from your fund every year.
Flexible drawdown – as the title says, this is a much more flexible option and is available to you as long as the meet the MIR limits (Minimum Income Requirements) and are no longer contributing to any pension.
Why might you choose the Drawdown option?
Drawdown is a helpful option when it comes to planning your tax liabilities. Because it is totally variable, you can vary how much you drawdown and therefore how much tax you pay. You can also continue to work whilst you are still investing, hence your fund value may increase. People also use the Drawdown when planning their estate so that if you draw the bulk of the money before your death, inheritance tax will be reduced.
Upon your death, you also have various options to consider. The Drawdown can continue so that your family will benefit, an Annuity can be purchased or a final taxed lump sum can be obtained and paid as death benefit.
Don’t forget when selecting the Drawdown option that if you are investing it, there is some risk involved so you may increase the total fund or it may reduce.
As with all pension decisions, it is recommended that you take expert financial advice before making any major commitments. You will rely on your pension once you retire, so you need to be certain that you are getting the best value for money and the income plan most suited to your particular personal circumstances.