Every profession has its own jargon, but we can hold our hands up and say that the term ‘unsecured pension’ is not our fault. When the facility to draw an income directly from your pension fund was launched in July 1995, we called it Drawdown (although the government preferred pension fund withdrawal).

It was only with the changes brought about by so-called pension simplification, that the term ‘unsecured pension’ was forced upon us.

Actually, there is nothing wrong with this new term other than it fails to explain precisely what the facility means –on the other hand, it does cover one important aspect, which is that unlike an annuity, it does not provide a guaranteed basis of income. We will come back to this later.

So what is an ‘unsecured pension’?
Basically, this is a facility that allows you (after taking any tax free cash that you may require, up to 25% of the value of the fund) to take money directly from the fund as a taxable income. The advantage of this is that you are not purchasing an annuity so you can decide exactly how much to take, within limits set by the government. These are basically anything from nothing at all, to 120% of the amount you could get from a single-life level annuity. To make this easier to calculate, the Government Actuary’s Department issues tables, which IFAs and pension providers can look up, depending on the most recent gilt yields.

Highly flexible
Perhaps the most important aspect of this is that you can actually vary the amount you take each year. This means that if you are retiring gradually, perhaps reducing the number of days you work each week, you can build up the level of income from your pension gradually, to compensate for reduced salary.

Most importantly, the balance of your fund remains invested within the highly tax-efficient regime applying to pensions. If you purchase an annuity, you no longer participate in investment markets.

Should you die ...
Unlike under an annuity, where on death the entire fund is lost or used to provide an income for a named dependant provided this was set up at the outset, on death while using an ‘unsecured pension’ the balance of the fund can be returned to the estate (less a tax charge of 35%) or used to provide a dependant’s income either directly from the fund or through an annuity.

What are the risks?
Using an ‘unsecured pension’ is not for everyone. Firstly there are generally higher costs than when an annuity is purchased, particularly on smaller funds. Secondly, you remain exposed to investment risk. Thirdly, you are not receiving a guaranteed income as you would, had you purchased an annuity. Fourthly, any future reduction in annuity rates could give a lower income in future than would have been available at outset.

This means that, in a worst case, your pension fund could run out. Conversely, you are keeping your options open and, if you believe that interest rates will recover – and therefore improve annuity rates – using an ‘unsecured pension’ for a year or two before purchasing an annuity could make sense.

At age 75
‘Unsecured pensions’ are available only from age 50 (55 from 6th April 2010) until you are 75. Thereafter new – much more restrictive – rules apply under the equally inelegantly titled ‘alternatively secured pensions’ (which industry people refer to as an ASP, largely because they can take a massive bite out of your fund when you die).

It is important always to seek independent financial advice before making any decision regarding your finances. For further information, please contact your usual independent financial adviser. The value of investments is not guaranteed; you may get back less than you put in.

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.