How do pension payments work?

Pension payments are the process whereby a pension pays out from the fund you have accumulated to you through one of the main methods of taking benefits from your pension such as a tax free lump sum, annuity payments or drawdown.

Each of these has varying limits and rules on how they work and what you can do with them in terms of pension payments and are explained below.

Tax Free Cash Lump Sum Pension Payments

When you reach the age of 55 you may at any time take 25% of your fund as a tax free cash lump sum. Once you have taken the full tax free cash your pension is considered crystallised and you may not take any further tax free cash from it unless you make further contributions to your fund.

Although this is pension payments in terms of annual income, the 25% tax free cash is a payment in that it is paid directly to you and you are free to use it however you wish.

You may even take the 25% at stages and not all at once meaning you may if you desire create your own type of pension payments from it by taking small bits at a time such as 5% a year for 5 years until you require further income.

Pension Payments: Annuity

Annuity contracts are the traditional way for pension payments to be made but since the budget report this year are now no longer required by law to be taken by the latest date of 75 and you may instead receive your pension payments in one of many other forms.

In essence, pension payments in annuity is a contract between you and an insurance company whereby you sell your pension fund to them in exchange for series of set pension payments from them.

The pension payments you receive from an annuity will depend on the annuity rates you when you take an annuity, the age you take an annuity at, the size of your fund to name a few. For a full list it is appropriate that you inquire from a suitable independent financial adviser and seek their advice on your retirement options and what pension payments you may be able to receive.

Pension Payments: Drawdown

Drawdown can be split into either capped or flexible drawdown when you are looking to take your pension payments. To take flexible drawdown you will require an annual income of over £20,000 from your relevant income and as such you should contact a financial adviser to see if you qualify for it.

However, most people will only qualify for capped drawdown which limits the amount of pension payments you can take from your pension fund to 100% of the appropriate GAD limit at that time.

With the removal of the need to buy an annuity by the age of 75 this option has proved a viable alternative for those who do not wish to sell their pension to an insurance company and instead prefer to keep it in their own pension fund whereby they can receive direct pension payments.

There are of course risks with drawdown of pension payments such as the possibility that you may use up all of your fund before you retire which is not possible with an annuity but it is not without its positives.