How does a reliable source of income sound for the years of your retirement?
Those that are fortunate enough with their health, enjoy life, without the uncertainty of worrying about income and have the freedom to be able to do whatever it is they want to do.
Do you want to do the things you want to do in retirement?
What are the advantages of having the flexibility of taking income in retirement using a Flexible Access Drawdown (FAD) account for example – instead of a fixed and steady stream of income payments that you would receive from a Defined benefit (DB) pension scheme?
Before we look at some advantages let’s think about the word flexibility in the context of pension income.
Flexible in this context means being able to take £10,000 from your pension if you want and then not taking any at all. Or maybe you take regular income payments of £3,000 and then reduce to £1,000 once other pensions (possibly those of your spouse) kick in and your eligible to claim the state pension.
Flexible means that any surplus funds can be bequeathed to children or whoever else you care to nominate.
This is not the case with DB pensions.
Further to government reforms to pensions in 2015 (pension freedoms) there are more options that ever for taking income in retirement.
The drivers from the reforms were ‘flexibility and control.’
On a consumer level anyway.
Viewed from a different angle the reforms were nothing more than unsaddling business with huge pension liabilities – forever forecasting higher into the uncertainty of the future.
But that’s another story for another day.
Now, circumstances dictate what’s best for you and if you have DB pension benefits of more than £30,000 you must take regulated financial advice.
This is a good thing.
Because things can be complex/technical, and the world is full of trickery and sharks eager to at best – charge extortionate fees and at worst fleece you of your pension all together and swindle you into some type of unregulated forest or crypto investments!
As such, always consult the FCA register and make sure you use a decent professional and authorised advisor.
Back to flexibility and some more circumstances.
Flexibility in the context of pension income in retirement means you can take more, or indeed less than you have available.
FAD enables you to take more at some points in time and less at others. Thats’ the flexible access part of FAD.
In comparison, the regular and secure income from a DB pension stays the same throughout retirement (usually increasing with inflation or thereabouts).
So, you can choose to have the ‘flexibility’ of taking more or less, as needs be. Alternatively, you can have a steady income stream that does not change too much right up until you die.
In terms of circumstances yours are very different to mine or his or hers.
For example, you may be fortunate and have a mortgage repaid for you main home together with a high yielding investment portfolio, full ISAs and other savings – and maybe a holiday home to boot.
On the other hand, you may be in poor health and not much in the way of assets.
The intent of the former may be to ensure funds can be passed on whereas the intent of the latter may be to enjoy what funds are available in anticipation of a shorter life.
Both are valid intents and w ho is to judge otherwise?
We all have different lives, different personal circumstances, different dreams and aspirations. Our personalities drive our decision-making processes, and our personalities are coloured by our experiences of life.
And so on an so on.
WARNING: If you make an informed decision that taking income in a flexible way is preferable to a steady and secure income there is no going back once a defined benefit pension transfer is made.
That’s why the FCA always view matters from the starting point of ‘it’s probably not in a clients best interests to transfer out of a DB pensions’ – unless you can prove otherwise.
It’s important to keep this in mind.
Likely Pattern of Benefits in Retirement – Till Death us do part
Much as in marriage. the solemn vow is taken ‘till death us do part’ – likewise with your pension.
Unlike marriage there may be less ‘nagging’ and instead the peace of mind of income to what you want to do. The freedom to sail that boat in the Caribbean, the freedom to sit in Wetherspoons or simply the freedom to play as much golf as you like.
However, the difference between dying when you have a DB pension in place compared to being in a FAD arrangement (which you would be after transferring) is broadly the following:
In a DB scheme, dying before retirement usually means your spouse will get 50% of your pension benefits paid for the remainder of their life. On their death the pension ends.
DB schemes vary and some may be more or less generous, in this respect.
Dying after retirement usually means your spouse will also get 50% of your pension benefits but many schemes will pay a lump sum (equivalent to the value of unpaid pension instalments for period) if you die within 5 years of retiring.
Some DB schemes also pay children’s pension if a child is under 16/18 or in full time education up to the age of 23 years or so.
If you decide to transfer and die before retirement the rest of your pension fund will pass to your spouse (if you’ve nominated them to receive this) and that’s the end of it. Any unused funds after your subsequent death has the potential for other family members to benefit from.
If you die after retirement the amount you have available decreases with time.
Obviously, dying immediately after retirement equates to a larger sum as opposed to living for years and years.
Age is significant as if you die prior to age 75 means it’s passes on ‘tax free’. If you die after the age of 75 tax becomes payable at your beneficiaries’ ‘marginal’ tax rate.
A dilemma if ever there was one!
Live, spend and leave nothing behind
Die, and leave everything!
A Flexible Angle to Death
You may come across the merits of the flexibility of death benefits once a transfer has taken place.
These are often portrayed as having the ability to transfer a DB pension and then perhaps buy an annuity. It’s possible that if you choose this route you may opt for a level of ‘spouses’ benefit of 50%, 66% or even 100%. It’s also possible to select a ‘guaranteed’ period of up to 30 years or so.
Selecting a guarantee period of 30 years paying 100% is going to cost a lot more than 5 years at 50%.
The irritating point to this apparent flexibility is that if an intention is to buy such an annuity then why bother transferring?
A DB offers a secure income. I know some will say. “well it depends on the size of the pot and other assets” etc etc.
But it just seems like a daft comparison.
Likely Pattern of Benefits in Retirement – What to consider?
Before any consideration can be given to transferring a DB pension a robust analysis of patterns of income and expenditure and likely patterns, into the future, must be established.
It’s easy to say what you have now.
Value the house, outstanding mortgage, loans etc. You can easily identify your spending patterns which falls into discretionary and non discretionary categories.
You cannot factor for inflation.
You can look at past results but as we’re all too aware past results are no guarantee of future results. This applies to inflation as much as it does to performance returns.
As such inflation may ramp up significantly – you just have wish that it won’t, and maybe your wishful thinking will pay off.
What other uncertainties are there?
Well, what about unexpected or unplanned needs for cash? Or what about if the ‘fall out of bed’ and your fund gets demolished?
Risks, risks you embrace.
You get the idea.
But to make a pattern that fits for the purposes of demonstrating that a DB pension transfer is suitable full consideration of current patterns and expected patterns is crucial.
Imagine you’re 58 and you want to retire earlier at age 60 (and your DB scheme kicks in at age 62 with no penalty for early retirement).
You lose your income from work and must replace this with income ‘drawndown’ from your transferred pension.
So, you cash in your DB pension and get 500k or so. You use some tax free cash (often called pension commencement lump sum or PCLS) of 50K to repay your outstanding mortgage.
You invest the remaining 450K
At the point you receive the state pension (age 66) and your spouse’s pension kicks in you have ample to pay all discretionary and non discretionary needs.
But what about from 60 to 66?
How much will you need each year?
Lets pretend you need 25K.
6 years X 25K = 150K
Excluding anything else your 500k is now 300k (ignoring any returns you may have had in the 6 years).
If you can then live ‘fine and dandy’ on yours and your spouses’ state pensions (as well has your spouse’s other pension) then your remaining pot (300k) can hopefully grow (via returns minus charges) and be left to your children.
A happy ending.
Of course, there are variables.
You may not need 25K each year.
Maybe you need 25K pa for 3 years then this reduces to 20K for 2 years and 10K for the remaining year. So a total of 115K leaving more in the pot.
Maybe you achieve significant returns with your investments?
Maybe inflation is kicked into the long grass and production supplies and supply chains resume their pre pandemic levels.
Maybe – a great word if ever there was one.
Almost as good as likely.
And that my friends concludes this trip down the ‘likely pattern of benefits in retirement’ musings.
Like thinking out loud it’s all too easy to focus too much on perceived benefits rather than really thinking about likely outcomes.