Things you must think about before you invest your pension
Pension freedom rules allowing people to keep their pot invested and draw on it as they choose have left many wondering how to invest for retirement income.
Savers with defined contribution pension pots no longer need to buy an annuity to provide them with an income for life and now have the flexibility to decide how they put their retirement fund to work instead. Yet these changes introduced on 6 April 2015 have also brought a challenge. Annuities may have been muchmaligned, but buying one meant that those retiring could secure a steady income for the rest of their life. Now those choosing to keep their pension invested and draw on it, or even withdraw the entire pot, must decide how they can deliver the retirement income they need. It could be all too easy to run down a pension pot too quickly and many people are concerned that they may make bad investing decisions, or invest a lump sum at a bad time just before markets tumble,
How can you invest?
There are now two options for those who want to keep a pension invested and draw on it. Drawdown involves taking a tax-free cash lump sum of up to 25 per cent of your pot and then investing the rest. This investment pot can then be drawn on for retirement income, with retirees able to choose how much they take out and when. This income is taxable. The other option is to keep your pension invested and take lump sums out when you need them, with the first 25 per cent tax-free and the remainder taxed. These are called uncrystallised funds pension lump sums. In order to use either of these two options you will need a provider that allows you to keep your pension invested and draw on it. Many pension providers and investment platforms allow drawdown but each will have different rules and charges on withdrawing money. If you want to take uncrystallised funds pension lump sums, choice is currently more restricted. Not all providers offer this and may restrict how often money can be taken out and impose charges. This could mean that you need to transfer your pension pot to a self-invested personal pension to take advantage of this flexibility. Savers should consider the major DIY investing platforms that allow them to manage their investments online and shop around for the best Sipp for their needs, keeping an eye on charges, ease of use and customer service.
What you need to think about
It’s important to know how much income you will need in retirement. This means sitting down and working out what your incomings and outgoings will be and how this will change as you get older. Savers need to consider how they will bridge the gap between the secure income they will have from other sources, such as their state pension and any other defined benefit pensions or annuities, and the income they need in retirement. They may want to consider buying an annuity to provide more secure income, even if it is only with part of their pension pot. It is important to check pension plans for any guaranteed annuity rates. Some older plans came with rates locked in that are much higher than those on offer now. These may be too good to pass up. Once you know how much income you need to generate, you can then consider the best way of investing to do so. With a large pension pot you may be able to simply invest in incomepaying investments, such as bonds and equity income funds and spend the income you receive each year. Alternatively, you may need to spend some of your capital to cover your needs and come up with a plan that means you won’t run it down too quickly. The concern over getting things right highlights the need to take your time over investment decisions and consider seeking guidance and professional independent financial advice. Decisions like this are where expert help really pays off.
Less than 10% of pension investors plan to buy an annuity
Where could you invest?
For most people funds or investment trusts that spread their risk for them are the easiest route to take. Investing in a selection of funds which can both grow your capital and produce income is a way to create a steady flow of cash over the years. By mixing funds that invest in shares, bonds and property and some cash, it is possible to put a safer income focus on your investments. You will need to take some risk, which means your sum invested could fall, but over the longterm your investments will benefit from the power the stock market has to deliver growth over time. It is important to not put all your eggs in one basket and avoid being over-exposed to any one area or specific risk. For those opting to pick investments themselves, DIY investing platforms can help you choose good funds and how to mix the different assets, particularly shares and bonds.