One of the pension freedoms options available to your retiring employee is to take a flexible income from their pension pot. It’s flexible because they can take different amounts of income at different times.
To do this they will need to transfer their pension pot to what’s known as a Flexi-Access Drawdown pension. It’s often simply referred to as FAD.
As with all of their options, your employee can first take up to 25% of their pension pot as a tax free lump sum. If for example, they had a pension pot of £100,000 they could take £25,000 as a lump sum with no liability to tax. This is often referred to as tax free cash. The remaining amount, usually 75% of their pension pot, (in this example £75,000), is invested in a FAD pension.
The money in the new FAD pension remains invested so its value may rise and fall depending on how the underlying investments perform. At any time they want to access their money they can simply ‘draw’ the amount of income they need ‘down’ from their FAD pension.
Most people need a regular income so it’s common to have income paid monthly, though it could be quarterly or even annually. Because it’s flexible they can stop and start as and when they like. The amount available to them is simply governed by how much they have left in the FAD pension. In fact, they don’t have to take any income if you don’t want to.
The FAD income they take is taxed just like any other taxable income they may receive, like a salary or wage from a job.
Because the money in their FAD pension is still invested, they’ll need to consider how and where to invest it and what might happen if their pension pot doesn’t grow as much as they had hoped or assumed. They may even be left in a situation where there is not enough money to provide them with the income they need. Your employee will need to carefully consider how much money to take out of their pension pot because the more they take out the less money is left to take in the future.
The money in the FAD pension is available at any time until they die. Any money they don’t take during their lifetime can be passed onto their beneficiaries.
FAD offers a great deal of flexibility in terms of when and how much income they take and their retirement income can be tailored to their specific needs. If their circumstances change, they can simply change how and when they draw their income.
FAD can also be used to take a cash lump sum if required.
Because the pension pot continues to be invested this option carries some risks. The income they will receive is not guaranteed so they may be forced to reduce it, they could even run out of money altogether. It will depend on how their investments perform, how much income they take and how long they live.
Unlike some of the other options available, retirees don’t have to continue with their FAD pension indefinitely. If their circumstances change they can use what’s left in their FAD pension to buy a guaranteed income via an annuity. They could even take the whole pot as a cash lump sum.
So FAD offers your retiring employee flexibility but may require regular reviews or even ongoing advice.
Like most things in life, there are advantages and disadvantages in any option they choose, and the same is true when looking at what to do with their pension pot. It’s therefore important that they work out what’s best for them given their personal circumstances.
There are a number of things your retiring employee will need to think about when considering flexi-access drawdown. These include: the size of their pension pot, what income level they anticipate needing, any other sources of income they may have, their attitude to taking risks, the future performance of their investment funds, the loss of any guarantees offered by their existing pension, how long they’re likely to live, whether they wish to pass on their pension to someone else when they die, the FAD pension charges, the need for reviews and ongoing advice and their entitlement to state benefits.
Many different companies offer FAD pensions and they may even be offered this option from their existing pension company. However, if they decide to take this option, they’ll need to shop around to be sure that they find the company who will give them the best FAD for their circumstances.
Contact the Love Your Employees team who can discuss innovative and cost effective and engaging ways of helping your staff to be better informed about their pension options and make better retirement decisions.
Author: Ian Beestin, CMO, Money Alive
© Money Alive Limited 2017