A simple guide to pension freedoms: what are your employees' options?

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Introduced ten years ago, the Pension Freedoms Act gave people more choice over how they can take their pension money. But how clued up are your employees about their options? Our guide explains all they need to know. 

What are pension freedoms?

This month, the Pension Freedoms Act celebrates its tenth birthday. Introduced in April 2015, it aimed to give people more flexibility when taking their pension savings. Before then, many people reaching retirement had to use their pension pot to buy a guaranteed income (also known as an annuity).

Since the introduction of the Act, there’s much more freedom. When people are ready to take their pension savings from age 55 (57 from 6 April 2028), they have several options to choose from.

Which type of pensions are covered by pension freedoms?

Pension freedoms only apply to Defined Contribution (DC) pensions. This is now the most common type of workplace pension in the UK, according to the most recent ONS data.

Pension freedoms don’t cover Defined Benefit (DB) pensions (also known as final salary). These usually pay a secure income for life, based on an employee’s salary and how long they worked for the company. According to the same ONS data, these have been in steady decline over many years, with DC pensions taking over as the most prominent type in 2019.

What are the different choices available to employees?

If your employees are approaching retirement, or simply planning ahead, it’s a good idea for them to get acquainted with the different ways they can take their pension savings. With greater choice comes greater responsibility over complex decisions, so it’s worth them thinking about which option would be right for their financial future. 

Below, we take a look at each option, as well as the financial wellbeing support you could offer to help your employees make confident financial decisions:

Drawdown

Pension drawdown – also known as a flexible income – allows employees to take their pension savings whenever they want (when they reach retirement age of course). They decide how much to withdraw, and anything left in their pension pot stays invested.

With drawdown, employees have the option of setting up a regular income. They could choose to take the same amount each month, or as and when they need it. 

With this option, an employee’s pension money isn’t guaranteed to last for as long as they might need it to. The value of their investments can go down as well as up and, depending on how much they take and how their investments perform, they could run out of money.

Annuities (guaranteed income)

With this option, employees can use some or all of their pension savings to buy an annuity. This gives them a guaranteed income for life or for an agreed period.
 
Employees can choose to add extra features onto the annuity. For instance, they could add a feature that increases their income every year, rather than it being a fixed amount. They can also choose how often they get paid (such as monthly or yearly). 

Once employees have bought an annuity, they can’t usually change how much they get or when they get it. 

Lump sums

Employees also have the option to take a one-off or multiple lump sums from their plan. They decide how much to take and when, and any money left in their pension pot stays invested.

Again, with this option there are no guarantees as to how long their money will last. Their pot’s value can go down as well as up, and they could run out of money if they take too much too early. 

A combination

Employees could go for a combination of different options.

For example, employees could buy an annuity with some of their pension savings, and have the rest in drawdown so they can take lump sums or more income. 

This could give employees the best of both worlds, where they have the security of a guaranteed income, and the flexibility to take the rest whenever they need it.

Does each option involve income tax? 

Whatever option an employee chooses, they can take up to 25% of their pension pot tax free. After that, they’ll usually need to pay income tax on their pension on anything over their tax-free personal allowance. If they take large, taxable lump sums, this could push them into a higher tax bracket.

How to support employees with their retirement options

Choosing how to take their pension savings is a big decision for your employees. As an employer, you’re uniquely placed to offer personalised, targeted support that can help them make more confident decisions about their financial future. 

As a starting point, you could signpost to tools that help employees understand how much they might need to fund their ideal retirement lifestyle. For instance, the PLSA’s Retirement Living Standards can show employees how much money they’d need each year to cover a minimum, moderate, and comfortable standard of living in retirement. If you’re with Standard Life for your workplace pension scheme, employees can also use our Retirement Income Tool to check if they’re on track to meeting their retirement goals. 

You could also point employees towards resources that help them get a better understanding of their retirement options. MoneyHelper, for instance, provides guidance on a range of pensions and retirement related topics. Standard Life workplace pension scheme members can also use our Money Mindset* platform to get instant access to a library of bitesize financial education content.

Employees can also use our Mixed Income Builder tool, to help them understand how they could combine the different retirement income options. Built using real member feedback and data from the PLSA, our tool shows employees how they can use some of their money to secure a guaranteed income for life and then take the rest flexibly whenever they want.

For more insights on how to support your employees, visit our Financial Wellbeing hub and read our articles.

*Money Mindset is provided in partnership with Moneyhub Financial Technology Limited

The information above is not intended as financial advice. If employees are unsure they should speak to a financial adviser.