"Wealth is not his that has it, but his that enjoys it"
"Wealth consists not in having great possessions, but in having few wants"
"Time is the most valuable thing a man can spend"
- Laertius Diogenes
"The glow of one warm thought is to be worth than money."
"I don't care too much for money for money can't buy me love"
- The Beatles
"Simple, genuine goodness is the best capital to found the business of this life upon. It lasts when fame and money fail, and it is the only riches we can take out this world with us."
-Louisa May Alcott, Little Men
"And though I have the gift of prophecy, and understand all mysteries, and all knowledge, and though I have all faith, so that I could remove mountains, and have not charity, I am nothing."
"Not he who has much is rich but he who gives much"
"Life is what happens to you while you are busy making other plans"
"I pity that man who wants a coat so cheap that the man or woman who produces the cloth shall starve in the process"
A Guide to Income Drawdown
- What is income drawdown
- How income drawdown works
- The tax position
- Continuing to make pension contributions once you have started income drawdown
- Investing within an income drawdown pension
- The position on death
- Comparing income drawdown to the alternatives
- Blending your retirement options
- Making your choices
This is a guide which aims to simplify a complicated subject; Income Drawdown is a wonderfully flexible way for you to manage your pension, providing you with an income which you can control and offering numerous added and other benefits.
HOWEVER there are risks and a number of factors to be aware of which could turn the attractions of a drawdown pension into something which causes you difficulty. We will outline for you, over the following pages, all the key factors, the pros and cons, the way to think about drawdown, how to manage a drawdown pension and much more. We offer this to you as a starting point; nothing, ultimately, is better than obtaining the best expertise and the best advice. If you are to use drawdown as a means of organising your income in retirement then you should only do so having taken such advice. Hopefully, though, the following information and ideas around this subject will help you on your journey.
What Is Income Drawdown?
Income drawdown is a way to take money out of your pension plan. You can take as much or as little as you like, as and when you need it, from the age of 55 onwards. You can take a tax-free lump sum (normally 25% of your total pension pot), a taxable income or a combination of them both, giving you the ability to take your income in a tax efficient way. Your pension remains invested – giving your money the opportunity to grow.
However, the investment funds you use must grow to compensate for the income you withdraw. If that doesn’t happen, the income you take will reduce your pension fund, possibly to nothing, especially if you choose to take a high level of income. Unlike some other retirement products, the funds or money remaining in your Drawdown Pension Plan can be passed on to your beneficiaries when you die. Income drawdown offers great flexibility, control, possible death benefit advantages, and the chance to keep your pension intact (or even growing) and has become especially attractive since the introduction of the new Pension Freedom legislation in 2015. Previous to this, annuities were the pension income product most commonly used by retirees. However income drawdown now offers so much more, that annuities are no longer the premier option.
How Income Drawdown Works
There are two main types of income drawdown “product”:
Flexi-access drawdown – introduced from April 2015, where there is no limit on how much income you can choose to take from your drawdown funds
Capped drawdown – only available before 6 April 2015 and has limits on the income you can take out; if you are already in capped drawdown there are new rules about tax relief on future pension savings if you exceed your income cap
We will focus in this guide on flexi-access drawdown; if you want to find out more about capped drawdown, please contact us for further help
TAKE AS MUCH AS YOU LIKE FROM THE AGE OF 55
How Flexi-Access Drawdown Works
You can choose to take a portion of your pension pot as a tax-free lump sum, this is normally a limit of 25% of the total pot value. You then move the rest into one or more funds that allow you to take a taxable income as you require. Most people will use it to take a regular amount, possibly to provide a monthly sum – but there are no restrictions, so withdrawals can be made to suit you.
You should invest into funds or other permitted investments that are right for your objectives and are in line with your risk position. Once you’ve taken your tax-free lump sum you can start taking the income right away or wait until a later date. Alternatively you can move your pension pot gradually into income drawdown. You can take up to a quarter of each amount you move from your pot tax-free and place the rest into income drawdown. This means you can stagger your position, the advantage of this is that you can keep your pot growing – and your tax free lump sum value may also increase. This can provide, in the right circumstances, very tax efficient withdrawals. To help provide more certainty, you can at any time use all or part of the funds in your income drawdown to buy an annuity or other type of retirement income product that may offer guarantees about growth and/or income. You need to carefully plan how much income you can afford to take under flexi-access drawdown otherwise there’s a risk you’ll run out of money.
This could happen if:
- you take out too much in the early years
- your investments don’t perform as well as you
expect and you don’t adjust the amount you
- you live longer than you’ve planned for
If you choose flexi-access drawdown, it’s important to regularly review your investments. This is an area of financial planning where specialised and expert help will come into its own. Not all pension schemes or pension companies offer flexi-access drawdown. Even if yours does, it’s important to compare what else is on the market as charges, the choice of funds and flexibility may vary from one provider to another. Comparing products yourself will be difficult so it’s best to get financial advice.
Continuing To Make Pension Contributions Once You Have Started Income Drawdown
If the value of your pension pot is £10,000 or more, once you start to take income, the amount of defined contribution pension savings which you can get tax relief on each year falls from £40,000 (the ‘annual allowance’) to £10,000 (called the ‘Money Purchase Annual Allowance’ or MPAA). If you want to carry on building up your pension pot this may influence when you start taking income.
The Tax Position
Any money you take from your pension pot using income drawdown will be added to your income for the year and taxed in the normal way. Large withdrawals could push you into a higher tax band so bear this in mind when deciding how much to take and when. If the value of all of your pension savings is above £1m when you access your pot (2016-17 tax year) further tax charges may apply
Investing Within An Income Drawdown Pension
The key feature of using income drawdown is that your pension pot remains invested. This means you will need to decide which funds, or other types of investment, you wish to use to manage your pension through your retirement as you are taking your income from them.
This decision is probably the most important aspect of your arrangement. This is because the growth you obtain will determine whether your pot remains intact and for how long – if your income exceeds your growth rate (after costs etc.) then your pot size will decrease.
Of course, you may not get growth at all, if you choose investments or funds which fall in value then you would be withdrawing income from a depreciating pot size. A devastating combination. This highlights the biggest risk involved in using drawdown. There are surprising aspects to this, most relevant is that the Safe Withdrawal Rate (SWR) is considerably lower than many people may realise. See further sections below.
How you invest is a critical factor in the management of your position and could determine the success or failure of your retirement income targets. Failure could easily include your pension pot running dry in your lifetime.
The Position On Death
What happens when you die? You can nominate who you’d like to get any money left in your drawdown fund when you die.
- If you die before the age of 75, any money left in your drawdown fund passes tax free to your nominated beneficiary whether they take it as a lump sum or as income. These payments must begin within two years, or the beneficiary will have to pay income tax on them.
- If you die after the age of 75 and your nominated beneficiary takes the money as income or lump sum, they will pay tax at their marginal rate. This means that any income or lump sum taken on or after this date will be added to their income and taxed in the normal way.
Comparing Income Drawdown To The Alternatives
Is Flexi-access drawdown right for me?
Income drawdown is a complex product. We will be able to recommend whether it’s suitable for you. If it is we will compare what’s on the market and find you the most competitive product. Your other retirement income options include withdrawing the whole of your pension pot as cash and taking it out in one go. It is highly likely this is NOT a good idea in all but the most exceptional circumstances. Apart from any other reason, you would most probably be facing a significant tax charge for doing this, a tax charge that would probably be avoided either in whole or in part by taking the pension in stages or as income on a yearly basis. A more realistic option may be an annuity.
Although annuities have become less popular due to their very low income rates (as at the time of writing) and are considered inflexible and, possibly, inefficient on death, they do retain some attractive features. For example they provide certainty of lifetime income, which for many people de-risks their position to a
There could be an alternative with fixed terms annuities. Unlike annuities which are lifetime income products, the fixed term alternatives provide a short term income certainty, for example for five years, at which point they need to be rebased or something else done with the money. In an environment of low income returns, this could be a means of getting certainty for a short period without ‘locking in’ the income rate for life.
Blending Your Retirement Options?
Another possible alternative could be to mix the income products used, for example you could put half your money into income drawdown and half into an annuity, either lifetime or fixed versions. You can play with such combinations as you like to fit your circumstances.
Making Your Choices
The most important factor is to get a full, professionally prepared, appraisal of your position before making your decision. Hopefully your retirement period is going to be long, stretching over decades, and one that is enjoyed in good health. However, it is definitely the case that the future is almost certainly going to be difficult to predict, in many different ways. Not only is it probable you won’t know how long you have to plan for, you will also not know for sure your health position (and therefore your care requirements) as well as much wider and more general factors like future investment returns from different asset classes; future annuity rates and the wider economic patterns (for example, how inflation will behave).
All of which suggests there is plenty of room for things not to work out; generally speaking this suggests that you will need to do two things:
- Make sure your plans are flexible
- Have an active ongoing management of your position to adjust for changes.
MAKE YOUR PLANS FLEXIBLE AND ADJUST FOR CHANGES
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Getting Help And Support
We can help you with all this. There is possibly no area of financial planning where obtaining the right professional help is more important. Retirement is usually a permanent state, few people retire then decide to, or want to, return to work. The emphasis on avoiding financial mistakes is of paramount importance. Whereas earlier in life such errors can be overcome and recovered, in retirement they can be unrecoverable. There are many aspects to income drawdown that can represent a risk and can make it complex; there are many different ways any individual can use drawdown and how it is arranged will vary from case to case. All of which stresses the importance of professional help, from an appropriate expert. Contact us today.
We are able to support you in deciding:
- Is drawdown right for me?
- If so, do I allocate all my pension money into drawdown?
- How much income can I afford to take?
- How do I organise this most tax efficiently?
- Where should I invest the pot?
- Which pension provider should I use to run my drawdown?
- How do I manage my risks?
Readers should not rely on, or take any action or steps, based on anything written in these guides without first taking appropriate advice. Interface Financial Planning Ltd cannot be held responsible for any decisions based on the wording in these guides where such advice has not been sought or taken.
The information contained in these guides is based on legislation as of the date of preparation and this may be subject to change. We will aim to keep them up to date but inevitably there may be a time delay so current legislation should always be checked.