Although some people have the benefit of final salary pension schemes guaranteed by their employer, most people who wish to ensure they have more retirement income than the state pension provides, save using either a private pension plan (PPP), or an occupational defined contribution pension scheme. The funds put into the scheme are invested by the pension fund manager. For younger people there can a major proportion of the fund invested in equities, as these provide the best opportunities for long term growth, but as the person approaches retirement age the fund manager will change the balance of the fund to emphasize cash and government bonds, protecting the growth that has already been achieved. On retirement, part of the pension fund may be taken a lump sum, and the remainder is either used as an unsecured pension (USP), or an annuity may be purchased to provide a guaranteed life-time income. Annuity quotes may be very easily found online, as there are now several comparison websites in operation.
When a person is approaching retirement age they must make some choices about what to do with the contents of their pension fund. According to current regulations the pension fund cannot be touched until age 55, and if the fund owner survives to age 75, purchase of an annuity becomes compulsory.
A lump sum can be taken from the fund after age 55. This can be up to 25 per cent of the fund’s value, and no tax is charged on this sum. In the case of small pension funds the government allows 100% to be withdrawn, under the so-called triviality rule.
The remainder of the fund can either be used to purchase an annuity, or it can be left in the fund where it can provide an unsecured pension (USP). Note that USPs are sometimes called income drawdown.
Income drawdown, or unsecured pension, is not suitable for all retirees. One benefit of this option is that the fund will remain invested, and it may continue to grow in value. Additionally if the retiree dies the fund will form part of the estate, and can be inherited by the beneficiaries of the will.
The danger with income drawdown is that if the retiree has a long life after retirement, then the fund will become exhausted. Actuaries can calculate the point in a person’s life at which income drawdown becomes a worse option than annuity purchase, and it is always recommended that those using drawdown employ an independent financial advisor to conduct regular reviews.
Annuities are an insurance instrument, purchased from a life assurance company. The life company takes the pension savings, and guarantees the retiree a life-time income. The life company is, in effect, assuming the risk that the person may live for a long time, in which case the company would lose money on that particular annuity sale. This is however simply the trading of individual risk for collective risk, which is inherent in all insurance business.
Annuities can be bought from any life assurance company, there is never any obligation to buy from the pension fund manager, although they will normally make an annuity offer. Annuity quotes from many companies can be very easily found, as there are now several comparison websites in operation.
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