If you want to dip into your pension, be quick

The age at which you can get to your retirement pot rises from 50 to 55 from April next year.
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The Independent Online

Early retirement is a dream close to the hearts of millions of Britons. But a key way to reach this dream – through collecting personal and company pension benefits early – is about to get more difficult. From 6 April 2010 the age at which people will be allowed to collect their pension will rise to 50 from 55. Any saver wanting to take their pension benefits early will have to act fast.

“If you want or need access to your pension before you turn 55, you need to get it sorted out quickly. It can take several months to gather all the necessary information, and if you leave it till next year it could actually be too late,” warns Alasdair Buchanan, from insurer Scottish Life.

The reforms could potentially scupper the early retirement plans of many who are simply unaware of the changes afoot. Only those retiring early on the grounds of ill-health will be permitted to get their pension funds before the age of 55.

This will affect not only the well-off who want to retire early, but those who may need a lump sum in a hurry. “A tax-free lump sum now could be a real benefit, perhaps even a home-saver in cases of impending repossession,” says David Thurlow of independent financial advisor (IFA) Atkinson Bolton Consulting.

If you do decide to take your pension early, the usual choices apply. You can take a tax-free lump sum, an income, or a combination of the two. Up to 25 per cent of the total pot can be taken and is not liable for tax, leaving the rest of the fund to accumulate. The cash can be used to pay off debts or be reinvested.

“Taking tax-free cash and investing it in this way means you can keep the tax breaks, but have the option of dipping into the cash if an emergency should arise,” says Paul Sweeting, professor of actuarial science at the University of Kent. The remaining three-quarters of your fund can then be used to buy an annuity or be transferred into a drawdown fund.

If your main concern is a guaranteed income, buying an annuity is the obvious answer, but it is rarely beneficial to take out an annuity with your pension provider. Shopping around a variety of providers can increase your income by up to a third.

There are several annuity options available. Standard annuities involve trading a lump sum of cash in exchange for a taxable payment each year until you die. Payments are dependent on the size of your pension pot, annuity rates at the time and your predicted lifespan. Limited-period annuities work in the same way but last for only five years, after which a standard lifetime annuity can be purchased. This is risky, though, as annuity rates could have fallen even further once the five years are up. Inflation-linked annuities, which are set to increase by a fixed amount or by the Retail Prices Index year on year, can help to protect against the rising cost of living. However, these tend to start off paying around 30 to 40 per cent less than standard annuities.

If you have health problems, or if you smoke, shop around for an enhanced annuity, and complete a medical questionnaire, as these pay a higher rate of return for those with reduced life expectancy.

Finally, you can opt for a value-protected annuity which will typically pay a lower income on the understanding that the remaining pot passes to your heirs when you die.

But the biggest problem is that rates are likely to be poor for anyone under 55. If you don’t want to commit to an annuity, an income drawdown plan is a more flexible alternative. Once your pension fund has been transferred into a drawdown fund, you can either take an income, or defer taking any income until you decide to purchase an annuity. “You do get more flexibility and the freedom to turn your income on and off, but you also get continued market risk,” says Tom McPhail, from IFA Hargreaves Lansdown.

Poor investment performance could result in the value of your pension fund plummeting, leaving you with too little to buy an annuity at the same rate as now. Also, drawdown charges tend to be higher than standard pension charges and, if you are drawing an income, there is the added risk that your fund will not grow quickly enough to keep up.

Anyone planning to take benefits early must be sure that they will have enough left to retire on. The money can only be spent once and you will miss out on considerable potential growth by dipping into your fund early.

For some, taking pension benefits now will be the right decision. Savers with surplus funds to meet retirement requirements may well find a better use for that money. The cash could be used to build up pension funds in a spouse’s name, for example, to take better advantage of tax-free benefits.

“While most people would choose to do nothing, for anyone who has the choice, and who might want to draw a pension or a tax-free lump sum before age 55, decisions and action need to be taken now,” says Mr Thurlow.

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