What choices do individuals have in the decumulation phase?

This article is part of
Guide to retirement income pathways

What choices do individuals have in the decumulation phase?

Individuals moving closer to their retirement age may wonder which source of wealth to access first.

This is perhaps unsurprising as, thanks to the pension freedoms, individuals no longer need to only use annuities when it comes to converting pension savings into retirement income - a process known as decumulation.

Pension freedoms, which were introduced in April 2015, mean that instead of an annuity that offers a guaranteed income during retirement, pensioners can leave their money invested in the stock market.

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Sir Steve Webb, director of policy at Royal London, says: “The advent of pension freedoms in 2015 has given individuals much more choice over what they do with their pension pot and how they manage their retirement.” 

He adds: “For those who are part of a couple and perhaps have multiple pension pots, the range of choices can be very wide, and good and timely advice can make a big difference.”

Nathan Harris, a chartered financial planner at Lothbury Group, says the three main options for decumulation remain: annuity, drawdown and a “third way of offering parts of both options”.

He adds:“[While] the annuity remains the low-risk option, pension freedoms has made drawdown more popular and the third way offers some of the safety of annuities and the flexibility of drawdown.”

Deferring tax-free cash

Several experts in the industry say that individuals should defer their access to tax-efficient sources of income while decumulating their wealth.

Kate Smith, head of pensions at Aegon, says: “The order in which savings are taken is key to reducing the amount of tax people pay in retirement.

"In fact, prioritising which savings are used up first can be almost as important as saving itself."

Ms Smith adds: “Typically, money shouldn’t be taken out of a tax-advantaged savings plan until people actually need the income.”

She explains retirement income is taxable income, so clients need to avoid jumping up a tax band and paying more tax than they need to.

Mihir Kapadia, chief executive of Sun Global Investments, says it is important for consumers to have financial retirement strategies that contain cost-effective solutions to manage.

He says: “The return risk can be lessened by having a diversified multi-asset investment approach.

"An example of this can be through the use of lower cost index-tracking funds, or through exchange-traded funds, which provide a degree of certainty through a lower fee drag for each given asset class in that allocation."

Mr Kapadia identifies that the following options are available to consumers for decumulation:

  1. Buy an annuity without the restriction that was previously applied. This is a suitable option as, before the reform, payout in the form of a lifetime annuity was only possible if the decumulation scheme met certain conditions.
  2. Take a scheme pension.
  3. Choose a flexi-access drawdown arrangement which will see some of the investment risk managed on behalf of the consumer.
  4. The Uncrystallised Funds Pension Lump Sum option, which is a series of lump sums where 25 per cent of each withdrawal is tax-free.

How to get decumulation right

Steve Pennington, head of wealth planning at Arbuthnot Latham, says the biggest dilemma that is often faced by individuals who have reached retirement is the question of “which pot of wealth to access first?”.