Welcome to a world of BC and AC — before and after coronavirus. There is little doubt that all kinds of long-term changes are inevitable after the pandemic recedes — and that includes our financing of retirement.
For those of us who have already seen Covid-19 eviscerate our pension pots, this will be worrying. The situation gets more complicated as you draw closer to retirement.
Those who have opted to keep their pension money invested via an income drawdown arrangement have the immediate option to live off the natural yield of their investments or any cash they may have in their account, without depleting the capital. But will this be enough? Here are five ideas to protect your pot post-pandemic.
1 Look into partial drawdown
Partial drawdown and UFPLS (uncrystallised fund pension lump sum) are two similar concepts with subtle differences.
Partial drawdown is often used to describe a process where you crystallise a portion of your pot and then take the tax-free cash from that, but you may not necessarily withdraw the remaining 75 per cent of the crystallised amount.
Let’s say you have £100,000. You take £5,000 in tax-free cash, crystallising £20,000, but take no further income. Then later you take another £5,000 in tax-free cash, crystallising a further £20,000. At that point you have £90,000 remaining (£30,000 crystallised and £60,000 uncrystallised).
An UFPLS would involve you taking out a lump sum at each stage and only crystallising that amount. So if you took a £10,000 lump sum, £2,500 would be tax-free, £7,500 would be taxable and you would have £90,000 remaining which would all be uncrystallised.
Taking cash from a fund via partial drawdown (rather than UFPLS) has the advantage of not triggering the money purchase annual allowance (MPAA), which slashes the amount that can be saved tax free into a pension. This is very important for those aged 55 and over who intend to dip into their pensions while carrying on working through the crisis and rebuild their pension pots later, since it can severely reduce their future pension saving ability. If the MPAA is triggered, as it will be with UFPLS, the standard annual allowance falls from £40,000 to £4,000.
The benefit of both partial drawdown and UFPLS, though, is that they keep gross withdrawals as low as possible and will help protect against reverse pound cost averaging — the adverse effects of making regular withdrawals. As you are not withdrawing the full amount of tax-free cash you’re not cashing in unnecessary units to get the income you need. It also means you will naturally pay less income tax — none at all if you keep taxable withdrawals below the personal annual allowance.
2 Don’t discount an annuity
While underlying annuity interest rates are low, remember that if you have a medical condition, you may be able to get an enhanced rate as this will be based on your life expectancy. Investigate this option and see what rate you can obtain as most will differ from person to person.
This way you can make an informed decision on whether you can afford to retire on the annuity income or if you think it is worthwhile deferring in the hope of securing a higher income. The latter might happen if interest rates were to increase, your health deteriorated or you benefited from mortality gain (although of course none of these are guaranteed to happen).
Remember there is no such thing as a standard annuity rate. Even height and weight will make a difference to the rate you can obtain. If you have any medical conditions, make sure you complete a medical questionnaire thoroughly as you could get a good uplift on the annuity rate even in the current low interest rate environment.
3 Keep contributing
It might seem like a tall order if you’re worried about keeping your job, but try to keep up your pension contributions to make the most of tax relief and pound cost averaging.
If you are on furlough, unless you are told otherwise both your own pension contributions and your employer’s will continue at the current rate but will be based on the amount you are paid while on furlough. If you still have some form of an income, even with your employer cutting pension contributions, there is nothing stopping you from continuing to contribute.
Think carefully before you reduce or suspend your contributions, or opt out of your pension plan, as it will have an impact on the value of your pension savings when you come to retire. Don’t add fuel to the fire if you can help it.
4 Check to see if your pension is “lifestyled” up to retirement
If you are considering an annuity in retirement, you will want to gradually reduce the risk of your pension the closer you get to retirement. Most pension administrators will have online accounts where you can check this. The scheme booklet should also give an overview of the lifestyle strategy. Failing that, you can phone the administrators and ask for details of the investment strategy and options.
5 Keep an eye on your income
When looking at investment options, you have probably considered income generating funds, as you can withdraw the income without selling units.
Cuts to company dividends are an obvious concern as these will affect your income payments. Unless you have other income sources, such as rental income, guaranteed pensions or a “rainy day” fund then you may be forced to sell units. This is why, if you are investing in drawdown for retirement, you need to ensure you have at least six to 12 months of savings in cash to help see you through the bad times.
If you are receiving a regular income through drawdown, now would be a good time to reduce withdrawals to protect the fund as you are unlikely to need as much income. With everyone locked down, your discretionary spending will have reduced.
Enforced isolation has confronted many of us with an unexpected opportunity to reassess things and your pension should be no exception. Use the current situation to prepare for the future. Make sure you have sufficient cash or a guaranteed income — your state pension, an annuity or defined benefit pot — to cover the essentials. As Covid-19 has taught us all, you really never know what is waiting around the corner.
This article has been amended since publication to reflect the fact that taking UFPLS will trigger the Money Purchase Annual Allowance.
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