June 19th, 2017
When you retire, you don’t have to go down the route of purchasing your pension known as an annuity. You can consider Income or Pension Drawdown
For many people who have spent a large portion of their working life (if not it all) paying into a pension, you may be unhappy to know an annuity provider could end up keeping hold of your money if you die in the early years.
There is an alternative to purchasing a pension on retirement which allows your pension to remain invested and for you to take a portion from the pot each year as an income, hence the phrase ‘Income Drawdown’.
Income Drawdown, which from April 2006 became known officially as Unsecured Pension and from April 2011 will be known as Capped Drawdown and Flexible Drawdown– has the advantage of possibly leaving your family some legacy when you die, as your pension pot (after a tax of 55%) passes on to your family according to your wishes.
However, there are risks with opting for Income Drawdown.
- Your income is not guaranteed for life: you only have an income so long as you have a pension pot, so if you empty your pot you will face later retirement with a much reduced income.
- As well as this, because your pension remains invested, the value of it could go down – at a time when you’re probably not in a position to “replace” this loss with new money.
Principally, a Pension Drawdown plan allows you to unlock the tax-free cash from your pension plans without taking out an annuity. You retain ownership of the funds and the funds continue to be invested. A pension drawdown is an alternative to an annuity which gives greater flexibility.
The main features of a Pension Drawdown plan are:
- You can take a 25% tax-free lump sum from age 55
- You can take an income between 0 and 100% of the rate set by the Government Actuaries Department (GAD). More information can be given by one of our advisers on this complicated method of calculating the level of income.
- The income you withdraw can be varied at any time up to the maximum amount to suit your needs or control your tax liabilities
- The maximum income is reviewed and recalculated every three years currently
- You can transfer any number of pension plans (personal and occupational) to one single income drawdown plan
- You retain ownership of your pension fund and control of your investment
- Choice of death benefits for dependents
- Your Spouse can receive 100% of your fund on your death
Income Drawdown Plans in place before 6 April 2011
If you started an Income Drawdown plan before 6 April 2011, you will have to convert to the new rules, or purchase an annuity. There are transitional rules in place, giving you a deadline to do this.
The new income drawdown rules are as follows:
- There is no minimum amount of income that must be drawn, irrespective of age. This means that individuals may be able to leave their pension fund untouched for as long as they like, without the necessity to drawing any income.
- The maximum amount of income that may be drawn is reducing. The new maximum amount of income that may be drawn is 100% of the single life annuity that somebody of the same sex and age could purchase based on Government Actuary’s Department rates. An individual’s pension provider calculates the maximum income, using standard tables prepared by the Government Actuary’s Department (GAD).
- The maximum income will generally be reviewed every three years until age 75 and annually from age 75, based on the Government Actuary’s Department rates for an individual of the same age at the time of each review.
- Tax-free cash lump sums may now be paid after age 75 where an individual has elected to set aside or ‘designate’ funds for income drawdown at the same time, even if they decide to take no income.
If you are considering using income drawdown or delaying taking your tax-free cash lump sum and starting your pension after age 75, your Equity SMART adviser will check whether your pension provider is offering these options, and help you make the right decision.
How does Income Drawdown work?
Income Drawdown plans allow you to take benefits (tax-free cash and an income) from your pension funds without buying an annuity. From April 2010, the minimum age that you are able to take benefits is 55 (previously 50).
Income Drawdown (or Capped Drawdown and Flexible Drawdown) allows you to take benefits from your pension before the normal retirement age of 60 or 65, (sometimes referred to as “unlocking your tax free cash). Some people want to unlock their tax free cash early to use the funds to clear debts or repay a mortgage and the present rules allow you to do this from age 55. You do not have to stop work in order to take your benefits. You must bear in mind though, that by taking the tax-free cash (and any income) early you are reducing the funds available for you when you retire.
From the time of taking benefits (known as crystallising your fund) you can use Pension Drawdown to take both tax-free cash and an income. The fund remaining after taking tax-free cash is still invested as a pension fund, continuing to benefit from a tax efficient environment in the same way that it did prior to taking any benefits.
As always you must consider both the advantages and disadvantages of Income Drawdown.
- Access to tax-free cash immediately
- Flexibility to vary your income according to your requirements
- Control the level of income tax you pay
- Control of your investment
- Funds benefit from investment growth in a tax-efficient environment
- Choice not to purchase an annuity
- Option to take unlimited amounts if you meet the MIR (see Flexible Drawdown)
- Choice of death benefits for dependents
- Future investment returns are not guaranteed
- High withdrawals of income may not be sustainable
- The higher the level of income withdrawal chosen the less that may be available to provide for dependants
- Increased flexibility brings increased administration costs
- The level of income may change due to the reviews
Speak to Equity SMART about Income Drawdown and we will help you decide if this is an appropriate option for you.