The size of your pension fund may dictate which option you chose at retirement. What you do with a fund of £30,000 will probably be different to what you do with £100,000. According to the latest figures, £1bn has already been taken from pension funds since April, but what options are suitable for various fund sizes?
£30,000 and below
Since the reforms have come into force, those with £30,000 or less have been most likely to cash in their full pension pots rather than buy an annuity or go into income drawdown. The reason mainly comes down to tax. Pension income is added to other income in the year it’s taken to calculate annual income tax liability. The higher rate tax threshold of 40% starts at £42,385 (2015/16), therefore when a pension of less than £30,000 is added to a state pension, it would generally fall below this amount (subject to no other pension income being taken). As a result, a full pension can be cash in at basic rate tax of 20%.
To enter income drawdown with £30,000 or less would probably incur some setup costs which might outweigh any growth potential at least in the short term. If there was a setup cost of £500 to enter drawdown, it calculates as 1.6% of a £30,000 fund whereas it’s 0.5% of a £100,000 fund. Hence drawdown traditionally being for larger funds.
Using £30,000 or less to purchase an annuity would roughly produce around £1,500 as an annual income. Although an annuity provides a guaranteed lifetime income, the annual probably won’t make a huge different to many. As a result, there is logic as to why most with these pension fund values are withdrawing the full amount.
£50,000 pension fund
Those with a pension fund around £50,000 are required think a little more carefully about their options. A full withdrawal will more than likely result in some of the income falling into the 40% tax band. A more careful strategy is therefore required.
For those who are looking to withdraw their money as soon as possible but don’t wish to pay the higher rate tax, withdrawals need to be made over multiple tax years. Two of the new products brought into use on the 6th April 2015 will allow this, Flexi-access drawdown and Uncrystallised Fund Pension lump sums (UFPLS). Flexi-access drawdown provides complete flexibility and access to pension funds whilst UFPLS allow withdrawal to be made from existing pension fund without having to enter drawdown. With UFPLS 25% of any withdrawal is tax free and 75% is taxable income.
£100,000 pension fund
A retirement fund of £100,000 and above allows all options to be realistically considered. Purchasing an annuity would provide an average income (without medical enhancements) of around £5,500 for a 65-year-old. For those who want the certainty of a life time income, this, when added to the state pension might be enough to meet annual outgoings.
Income drawdown is much more suited to this level of fund than the lower amounts. The level of complexity within an investment portfolio is ultimately down to what the investor is willing to pay. There are over 100 companies who offer access to drawdown and around 4000 investment funds. Finding the right fit can be an onerous task. There are low cost solutions from companies such as Royal London and LV who offer access to the facilities of drawdown but with a low fund management and platform cost. The vast majority of the providers fit into the middle ground which offer access to a wider range of funds and some prebuilt, in-house portfolios. The advantage of the in-house portfolios is that they are rebalanced regularly to ensure that the whole portfolio stays within a certain risk, volatility or asset allocation range. If a portfolio of funds are self-selected and not monitored they can often drift into other risk levels, if one fund manager starts to buy more equity for example.
At the higher end of service is the discretionary manager often referred to as a DFM. There are generally two types of DFM. The ones who work closely with the client. Listens to their preferences (ethical stance is a common one) and tailors a portfolio on an individual basis. For this level of management there is usually a minimum fund requirement of around £250,000. The other type of DFM’s have prebuilt model portfolios, they are not bespoke and are accessible at a much lower minimum fund entry point.
There is no right or wrong answer as to which option suits a certain pot size. It really all depends on personal circumstances and priorities. If you’re unsure which is the best solution for your money, speak to a financial adviser.