If you have a personal pension or a stakeholder pension and don’t want to purchase an annuity, one option open to you is an income drawdown arrangement or unsecured pension with an insurance company. Income drawdown allows you to continue to keep your pension pot invested and take an income each year from your pension fund instead of buying an annuity.
Some occupational defined contribution pension schemes may also offer this option although you will probably need to transfer your pension savings to a personal pension first.
This approach lets you benefit from rallies in the investment markets and so possibly boost your retirement income. It also gives you a bit of breathing room if annuity rates are low, letting you postpone your annuity purchase for a while.
Plus, unlike an annuity, with income drawdown all of the remaining fund can be returned to your beneficiaries on your death.
How income drawdown works
An income drawdown arrangement lets people take out a tax-free lump sum on retirement and leaves the remainder of their pension saving invested in the markets. They can then draw off an income from their fund to support their retirement.
Every five years your pension provider will review the amount of income you withdraw, which must be below the limit set by the HM Revenue and Customs. You can withdraw any amount of income from your pension savings providing that it is below your limit. Income drawdown agreements do not have a minimum withdrawal requirement, so if you don’t need the income you can keep all your money invested.
However, you will need to use whatever is left in your pension pot to buy an annuity when you reach the age of 75. Or, if you prefer, you can transfer it to an alternatively secured pension. These policies are similar to income drawdown agreements – they just have slightly different rules and limits.
If you don’t want to use all your pension savings to buy an annuity you may want to consider a phased retirement agreement. These use part of your pension fund to buy an annuity and leave the remainder invested. Later on you can use another portion of your pension pot to purchase another annuity, and so provide a flexible income in retirement. Each time you use some of your pension saving to buy an annuity you can take some of the money as a tax-free lump sum.
However, you should be aware that annuity providers usually set a minimum amount for an annuity purchase.
Important points to consider with income drawdown
Income drawdown and phased retirement options are really only suitable for individuals with a large pension fund. Ideally, you will have other assets and sources of income that you can rely upon with these options.
These alternative retirement options are complicated and require thorough planning and management, so you should get professional financial advice before you proceed.
Compared to buying an annuity on retirement, income drawdown and phased retirement agreements are more expensive.
Income drawdown and the other non-annuity retirement options carry a much higher level of risk than an annuity. There is no guarantee that the investment markets won’t fall, leaving you with a smaller pension fund and forcing you to take less income. Taking money out of a fund when the markets are falling can reduce your pension fund rapidly, leaving you with less money to buy your annuity, perhaps less than when you first retired.
You will need to weigh up the advantages of delaying your annuity purchase with the costs and risks of income drawdown. A financial advisor will be able to guide you and help you compare your retirement options.