Pension Drawdown Explained
Pension Drawdown has been previously known as Income Drawdown (IDD) or Pension Fund Withdrawal (PFW). It later became known as Capped Drawdown or Flexible Drawdown but since April 2015 is officially called Flexi-Access Drawdown. (Some existing older plans may still be called ‘Capped Drawdown’.)
Flexi-Access Drawdown is the alternative to buying an annuity. Under normal circumstances we would expect your fund to be over £60,000, after you have taken your tax free lump sum, just to ensure that any costs of the plan are not overbearing. However, Drawdown may be the only method of meeting your objectives.
When you buy an annuity you are locked into the choice you make at that time and have no further flexibility. The ‘door slams shut’ on your income choices. By using Flexi-Access Drawdown you can always buy an annuity at any time in the future. You do not have to make decisions about picking a spouses’ benefit now or whether you should have increasing or level annuity payments. You can make these decisions in the future as your circumstances become clearer.
If you are over 55, it is possible to withdraw your 25% tax free cash lump sum from your pension fund and then have the balance (the other 75%) paid as a taxable lump sum. This is taxed as earned income for that year and will be taxed at your highest marginal rate. Therefore, taking this fund all in one go might not be a sensible thing to do if it pushes you into the 40% tax bracket. Why not take it over a number of years?
Your current pension plan may not offer the Flexibiliy of Flexi-Access Drawdown. For many pension companies making changes to old and outdated contracts is just not economical and there is a strong possibility that you will need to ‘transfer’ your funds to a Drawdown plan to obtain the flexibility you want. This is your opportunity to shop around and get some help with the investment. If Drawdown is selected as a solution it is essential that the investment is reviewed regularly to ensure that it is consistent with your objectives and on track.
Tax Free Lump Sum
This allows you to take 25% of your fund as a tax free lump sum without buying an annuity.
The balance of the money (75%) remains invested in a ‘Pension Bank Account’. We will discuss your attitude to investment risk with these funds and present a suitable portfolio of investments / funds for you. You do not have to make this important decision on your own.
You can draw an income from the ‘pension bank account’ each year, but you do not have to take any income if you do not want to. You have the choice to turn this income drawdown on and off like a tap if your circumstances are changing.
There is no maximum limit on the amount you can withdraw from your fund as income. Just remember that it is taxable. It is also worth remembering that this money was put aside with the intention of providing a long term sustainable income to support your retirement.
In the event of your death before age 75, your successors have three options. They could:-
- use the fund left and buy an annuity, tax free
- use the fund and draw income from it, tax free
- be paid the fund as a lump sum, tax free
In the event of your death after age 75, your successors have three options. They could:-
- use the fund left and buy an annuity, taxed at the beneficiaries’ marginal rate
- use the fund and draw income from it, taxed at the beneficiaries’ marginal rate
- take the fund as a lump sum, taxed at the beneficiary’s marginal rate.
Your ‘Successor’ is anyone you elect in an ‘expression of wish’. It could be more than one person.
The obvious benefit of leaving your beneficiaries a Pension Drawdown Fund is that it remains invested in a tax efficient environment with the potential for growth.
It is normally expected that you would be content to invest some of your funds in stocks and shares. This is because they have generally provided the higher investment returns over the longer term, and this allows your fund the opportunity to outperform the guaranteed income that would have been paid from an annuity. Risk is not an ‘On / Off’ switch. We can discuss varying degrees of risk and investment diversification.
Your eventual pension income will depend on how your fund grows, how much income you take out of your fund and the level of annuity rates in the future. You no longer have to buy an annuity at any time.
Because you are not locking yourself into an annuity and the choices you make when arranging an annuity, in terms of when you think you or your spouse may die, this is an opportunity to benefit from increased flexibility as your circumstance change in the future.
To find more advice on Pension Drawdown please click here for the Money Advice Service.
Warning: The value of investments can fall as well as rise and you may get back less than you originally invested.