Do you have multiple pensions? Financial planner Patrick Connolly takes a look at an investor's retirement savings options in: What should I do with my money purchase pension?
Should I take a cash lump sum or a pension?
Q: What is the obligation of an employer pension fund to transfer my lump sum to an open-market annuity provider?
In the 1970s I worked for an employer with a centralised final salary pension scheme for six years. For financial reasons, the scheme was radically altered in about 2005. I reached age 65 in July 2012 but have only just received a retirement quotation from this fund.
I have been offered three alternatives: a full fixed pension of £504 a year with no inflation allowance; a cash sum plus a reduced annual income; or a one-off trivial commutation lump sum of £11,559.
For the lump sum, I can obtain an annuity with a different provider of £667 a year, but the pension fund trustees say it is against their rules to transfer it direct to the annuity provider.
I could take the lump sum but will lose £1,734 in tax, and I could then only purchase an annuity paying £567 a year.
Could you clarify all this for me?
Philip Pearson is a partner at P&P Invest in Southampton
A: Unfortunately, the trustees of a final salary pension scheme are not required to provide an open-market option, which would enable you to purchase whatever annuity suited you.
When considering your options, it is worth noting that pension income is subject to tax if your annual income exceeds your personal allowance, which at your age is £10,500 this tax year. If you are a basic-rate taxpayer this will reduce the scheme pension from £504 to £403 a year.
However, you have the option of taking the money as a lump sum. This has the advantage of giving you control over how best to use it. If you do this, 25% of the lump-sum payment would be tax-free, with the remainder being taxed at 20%. This provides you with a payment of £9,825 after tax.
You could use this money to buy an annuity but I wouldn’t recommend it as you would lose the capital. Instead, you could reinvest it into a corporate bond fund via an individual savings account. It could then provide a tax-free income of about £450 a year, which is better than the net income you would receive from the pension scheme.
The Fidelity Moneybuilder range of funds provides good value, with no charges to set up an ISA. This will enable the ISA to be established with the full value of the lump sum while giving you access to the capital without any exit penalties being applied.
What is an open-market option?
Upon retirement most people have to take their pension pot and use it to buy an annuity. Around this time your pension provider will send you a pack telling you your retirement date is approaching and that your pension is going to mature, outlining the annuity they will sell you.
However, you don’t have to buy the annuity your pension provider offers you. This is where you can take an open-market option, which means you shop around on the open market, with other annuity providers, to see if you can get a better deal elsewhere.
The annuity you choose will determine how much income you receive for the rest of your life - so it is not a decision to be taken lightly. Going for the open-market option will usually get you a better deal but it is also worth taking financial advice to make sure you maximise your pension to get you the best possible retirement income.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Subscribe to Moneywise
Subscribe for just £1 and receive 3 issues
New subscribers take advantage of this fantastic deal with moneyback guarantee if you decide Moneywise is not for you.