The new pension freedom reforms give anyone who isn’t a member of a Defined Benefit Scheme, more flexibility in spending, saving and investing their pension pots. Previously, you had little choice but to buy an annuity. The problem here, as everyone knows, is that annuity rates are grim and are a relatively inflexible option. Some might say also, with annuity rates so poor, there’s been little encouragement to contribute to a pension.
The new pension freedoms offer an alternative to annuities –pension drawdown schemes. These schemes keep a pension pot intact, and allow you to drawn down income as and when. Each time money is taken out, the first 25% is tax free.
Research suggests most people are still primarily concerned about planning so that they have a reasonable income in retirement. Fears that people will blow their pensions on around the world cruises and the like, may turn out to be unfounded. But do the new reforms now mean annuities are a thing of the past?
Well not quite. As with any investment decision, risk has to be factored into the equation. One reason annuity rates are so poor is that they provide a fixed income. In a sense the annuity provider is shouldering the risk. With pension drawdown schemes any remaining retirement pot will still be invested thus exposing retirement funds to the markets. Investments can go up or down. The 55% so called ‘death tax’ on remaining invested funds has also been abolished. An annuity can’t be passed down to beneficiaries but the unused portion of a drawdown fund can be.
The differences don’t end there. As well as offering a fixed income, annuities also offer income for life. With a drawdown scheme there is a possibility an individual could run out of money. Annuities can also be enhanced for medical conditions. In the same way, a heavy smoker would get a better pay rate than someone with longer life expectancy. While annuity rates may be adjusted for inflation, a drawdown scheme offers the possibility of the retirement fund growing by more than inflation, although of course it may also go down.
Some of the advantages of drawdown schemes have previously only been available to the wealthy. However drawdown schemes are more suitable for those with a pension pot of at least £30,000 or £40,000. An annuity can be purchased with any size of fund.