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Many people automatically assume when they retire that their pension will start paying out, this is not the case you have to exchange your pension fund for an annuity. At this point you can use an annuity calculator to work out how much pension you will get.

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Pension Drawdown or Unsecured Pension

This involves you taking up to 25 per cent of your fund as tax free cash, and leaving the remainder of your pension fund invested. In the meantime, you can take income as and when you need it from the fund, subject to certain Inland Revenue limits, but you are not obliged to take income each year. If you want, you can choose to take no income at all for as long as you like until age 75 when you are obliged to either buy an annuity or transfer the fund to an Alternatively Secured Pension or ASP.

The minimum income you can take from an unsecured pension is zero and the maximum is roughly 120 per cent of what a single, level annuity would pay someone of your age. Unsecured pensions replaced "income drawdown" when the new rules for pension simplification came into force on 6 April 2006.

The advantages of taking an unsecured pension

Taking an unsecured pension has a number of advantages including:

• income flexibility - each year the amount of income taken can be varied between the minimum and maximum limits. Income can also be taken monthly, quarterly, half yearly or annually.
• control over your investments - if the unsecured pension is set up through a self invested personal pension or Sipp, there is a wide range of investment options available.
• choice of death benefits - unlike annuities where the only death benefits available are from a joint life, guaranteed, or money back annuity, drawdown offers a choice of death benefits.

The disadvantages

When you buy an annuity, you give up control of your pension fund in return for a secure income. With an unsecured pension, you maintain control of the pension fund but your income will not be secure, so it is a much more risky option than buying an annuity.

There are a number of risks involved when you defer an annuity purchase by investing in an income drawdown plan. Understanding and knowing how to manage these risks is very important.

• Investment risk – the value of your investments can go down as well as up.
• Mortality drag - if you defer purchasing an annuity, you will miss out on the mortality cross subsidy. The extra return required to compensate for the absence of this subsidy is called mortality drag.
• Decrease in your annuity purchasing power – If annuity rates fall and the value of your pension fund does not increase sufficiently to compensate, an annuity purchased in later years will provide less income compared to purchasing an annuity now.

Income Limits

The amount of income that can be paid from an Unsecured Pension fund is determined by reference to tables produced by the Government Actuary's Department (GAD). The maximum income in any one year is roughly equal to 120 per cent of what a level, single life annuity would pay someone of your age, while there is no minimum income requirement. This means that you can choose to take no income each year if you so wish.

To ensure that the income limits from drawdown are in line with annuities, the limits are calculated by reference to current gilt yields. GAD produces a set of special tables based on a range of interest rates.

Income Flexibility

Income can be varied each year so long as it is kept within the GAD limits. Income withdrawals can be paid monthly, quarterly, half yearly or annually and can be in advance or arrears.

Five-yearly reviews

There is a compulsory review of unsecured pension arrangements every five years to ensure that the pension fund can sustain future income payments. At the review, the minimum and maximum income limits are set for the next five years.

Pension Drawdown - Death Benefits

For many people, the more flexible death benefits are the most attractive feature of drawdown. Conversely, the most negative part of an annuity is the absence of any lump death benefit (unless you have purchased a joint life, guaranteed or money back annuity). On the death of the policyholder before age 75 there are three options:

• Take a lump sum death benefit - a surviving spouse or dependant may take the remaining pension fund as a capital sum, less a 35 per cent tax charge. The lump sum payment will be free of IHT, providing the correct trust has been set up.
• Continued taking unsecured pension - a surviving spouse or dependant may continue taking income withdrawals.
• Annuity purchase - a single life annuity can be purchased for the spouse or dependant.