In the previous post, we discussed why you might consider having an annuity as part of your pension plan. Here, we look at another couple of options available to you.
Unsecured Pension (Drawdown)
Drawdown – which is more properly called unsecured pension – is the main alternative to annuity purchase. Instead of handing your money over to an annuity company in return for an income which they determine the amount of, you get to keep you pension fund invested, stick a tap on it, and draw off what income you need when you need it.
Technically there are two types of drawdown, capped and flexi-access. If you already have a drawdown plan, it may be capped, but probably most new plans are written as flexi-access drawdown these days. Essentially it means you can take what you want when you want from your pot.
But the big downside is that rather than knowing you have a guaranteed income for life, however long or short that is, you now have the responsibility for keeping the money invested in such a way that it never runs out.
I like my friend Paul Armson’s picture of a bucket with a tap on the end. Imagine the level of water in the bucket is your pension fund. If you open the tap, the level of water reduces. The water level will also rise and fall with markets. Your job is to manage the investments and the level of spending to make sure the water never runs out.
For both annuities and drawdown, when you make the decisions to move some or all of your pension fund into these arrangements, you have the option to take up to one quarter of your pension fund as a tax-free cash lump sum. After the tax-free cash is paid, anything else you take from your pension, either in the form of regular annuity payments or drawn from a drawdown plan is taxed just like earned income.
UFPLS
One final little wrinkle is the so-called UFPLS, which stands for Uncrystallised Funds Pension Lump Sum. Here, rather than moving money into a drawdown account and drawing from that over time, the idea is that you decide how much lump sum you want and draw it straight from your pension fund.
Whatever that sum happens to be, one-quarter of it will be tax-free and the rest will be added to your income in the year for working out income tax.
Those are your main options for taking money out of a pension. Which ones work best for you are entirely dependent on your income needs, your feelings about investment and longevity risk and other factors.
Right! Let's crack on.
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