You, the taxman and your employer have been paying into your pension for many years and, unless it is a final salary scheme, you will need to choose, as retirement approaches, what to do with the accumulated ‘pot’. Put very simply, there are two alternatives, but there are various possible options under each of them. You can either buy a lifetime annuity or opt for the alternative of ‘drawdown’. Needs vary and choosing the right way to enjoy the benefits you have worked for during all those years is a big issue requiring expert advice.
A lifetime annuity gives you a guaranteed agreed amount of income for the rest of your life. The annuity is purchased from an insurance company using what has built up in your pension plan, less however much of the permitted tax free lump sum you decide to take on retirement (e.g. 25%).
It can be a single lifetime annuity to provide income only for you, or a joint lifetime annuity that will continue paying out to a surviving spouse or qualifying partner.
One key decision is whether your annuity should pay an increasing income to combat inflation. Inevitably, inflation-linked annuities offer lower initial income.
In addition, you could qualify for a higher ‘enhanced’ annuity rate if you unfortunately have a medical condition or lifestyle likely to shorten your life.
Under the drawdown arrangements, you are not obliged to use up your pension savings on an annuity; thus this is often the preferred route for high earners and those of you who have a large pension pot, as income flexibility and potentially superior death benefits are more important than simplicity.
One option is to use part of the fund to buy a fixed term annuity for up to five years, the rest remaining invested.
Separately, or in tandem with this, you can choose either capped drawdown or flexible drawdown. In each case your funds stay invested and the income generated will vary and not be guaranteed. There are income limits for capped drawdown, but flexible drawdown has no such limits, though to use this method you must have other pension income above a set minimum (£20,000).