Income Drawdown
Drawdown is a method of taking income from your pension once you have reached the minimum age, which is currently age 55.
Drawdown has many technicalities, it is complex and has variable aspects which you should be aware of, if you are looking to explore whether drawdown is right for you. The following is a simplified explanation of this subject – provided to outline the top-level factors and considerations. You should seek specialist advice from an appropriate qualified adviser before taking any action. In the UK today there are basically two types of pension scheme:
- Defined Contribution
- Defined Benefit
The drawdown options we will be explaining apply to defined contribution schemes, which are typically Personal Pensions, SIPPs and Stakeholder pensions, those pensions where there is a pot of money invested which you control.
Defined benefit pensions, such as a final salary company scheme, are different.
DEFINED CONTRIBUTION PENSION
e.g. Personal Pension
DEFINED BENEFIT PENSION
e.g. Final Salary Occupational Scheme
If you have a defined contribution pension scheme you will have three options at the time you want to start taking money from your pension:
You can: Withdraw everything. Convert your pension to an annuity – which can provide a guaranteed income for life. Or instigate Income Drawdown.
These three options are not independent of each other, you can do a bit of each or combine them. This video is not about which option is best or most suitable. We can help you decide on the options. But let us assume you are looking at drawdown for some or all of your pension funds.
How does drawdown work?
You can use your existing pension if it provides a drawdown facility or move to a new plan
(Some pension providers do not offer drawdown)
You can move pensions in stages into drawdown
Each time you move money into drawdown 25% can be taken as a tax free lump sum.
The remainder stays invested
From the invested amount you draw income
For example, you move £100,000 into drawdown
£25,000 is taken as a tax free sum
£75,000 remains invested
You can then take taxable income from the £75,000
From the amount that stays invested how much income are you allowed to take?
As little (including none at all) or as much as you like.
But remember any income you take is taxable, at your highest marginal rate of tax.
Also you need to be wary if you take too much income your remaining invested sum could fall in value and you could run out of money entirely.
For example imagine a pension with £75,000 in it and you elect to take 5% income per year. This is £3,750 taxable income per year.
Over the next three years after you start taking this income the invested sum falls in value by 20%, because of poor investment returns.
You have drawn 5% each year and your invested value has fallen. In this scenario your remaining sum after 3 years would have fallen from where it started £75,000 to about £45,000.
From there if you continued taking £3,750 per year you are now drawing an income percentage level of 8.33% per year of the reduced value.
It has turned into a very high income and – as a result - could decimate the remaining invested value even further.
This is why drawdown needs to be approached with great care and with great skill applied.
Regular reviews should also be made to the arrangement.
Drawdown is highly flexible, the income level is not fixed, you can reduce or increase the amount at any time, and you can even stop taking income if it is no longer required.
You can invest your money in drawdown wherever you like, provided it is a permitted investment.
For example you can invest in cash, shares, fixed interest and property (but not residential property).
You can invest into such areas either directly or using funds.
Any investments can change over time, and you should keep constantly reviewing the investment mix.
Cash 10% 20% 15%
Fixed Interest 30% 20% 25%
Shares 50% 40% 30%
Property 10% 20% 30%
And, of course, when running your drawdown plan there will be charges and costs, and this may vary from company to company.
So drawdown, whilst there are risks, is very flexible. Which for many people in their ‘pension years’ can be very important.
It can also be highly tax efficient and offer a better situation on death, than the annuity alternative.
However that is often determined by your personal situation and should always be tested by taking appropriate advice.
- Important things to consider
- Which company to use for my drawdown?
- Costs and charges?
- Attitude to risk?
- Capacity for loss?
- Where to invest?
- Income level?
- Tax position?
- Position on death?
- Consideration around alternative options?
The key to drawdown – assuming it is the right option for you – is to find the most suitable investment approach to manage the risks as best you can and in line with your attitude to risk, whilst generating the required income.
One final factor to stress is you can always convert to an annuity at any time. So your options remain open. In summary drawdown is a highly flexible way of taking income from a pension, but it needs to be treated with great care. As professional advisers we can help you with this.
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