Annuities and income drawdown
When you come to open your pension pot, you can either:
- buy an income - an annuity - from an annuity provider / insurance company
- keep your fund invested and take a regular income from your pot. This is known as income drawdown.
You can also choose to take all of your pension out as a cash sum and use it elsewhere. You will need to pay tax on the excess over the 25% tax-free lump sum.
Tax treatment of the pension and the cash lump sum
You do not have to pay tax on the cash lump sum, as long as you do not take more than a quarter (25%) of your benefits or pot as cash. (The proportion may be higher if you have a protected lump sum.) The amount over 25% will be taxed at your marginal rate. Your marginal rate is calculated based on your income in that tax year with the amount of your pension pot over 25% being treated as income.
An annuity is an annual retirement income that is paid to you for the rest of your life. You can normally decide the type of annuity you want. Annuities can include:
- A retirement income for just yourself;
- A retirement income for yourself and a dependent, such as a partner, if you think you’re going to die before them. It will typically pay a proportion of your income to them on your death (normally 50%);
- A retirement income which does not increase during payment;
- A retirement income which increases every year, such as in line with inflation;
- A retirement income which is guaranteed to be paid for a certain period, say 5 or 10 years, even though you may die in this period.
- An income which depends to some extent on the investment performance of the underlying assets.
- you can also buy an “enhanced” annuity if you have any sort of medical condition, which reflects the fact that your life expectancy might be impaired in some way.
Income drawdown is a way of taking income from the money you've built up in your pension fund without the need to buy an annuity.
The money remains invested in the fund, generally of your choosing and you take money from the fund as income, as and when you need it. You can take as little or as much as you want, subject to the terms and conditions of your contract. There may also be fees charged each time you take cash.
While you're making withdrawals from your pension fund, the rest of your fund continues to be invested, giving it the potential for growth.
However, the value of your fund or funds, can go down as well as up and is not guaranteed, so you may not get back what you have invested.
More information can be found at www.pensionsadvisoryservice.org.uk