What is Income Drawdown?
It is a plan that is much more flexible than an annuity, it allows you to draw a retirement income directly from your pension pot whilst leaving the rest invested. You choose where your remaining funds are invested and if your funds perform well, you may benefit from some growth over time.
How does Drawdown work?
You would normally move the pension fund you have been contributing to throughout your life into a drawdown plan, it doesn’t need to be the whole fund, you can decide. You can take up to 25% tax free cash and draw an income from the rest.
Most people take the 25% tax free cash as it is one of the only times you can take any money from a pension plan with no tax to pay. Any income is subject to income tax at your highest rate, so it’s important to take advice at this point to ensure you don’t take pay higher or additional rate tax where possible.
Types of Drawdown
There are two types of drawdown although these will be changing quite radically after April 2015 – Capped and Flexible Drawdown.
You choose an income between zero and the GAD maximum. The GAD maximum is equivalent to approximately 150% of a conventional single life annuity rate and is published regularly by the Government Actuaries Department. These maximums are fixed until the next review. The lower the income you take at the start (you can choose to take no income at all), the more your remaining fund should be worth, giving you a higher income in the future.
You can alter your income at any time between zero and the GAD limit. The GAD limits are normally reviewed every three years, but after April 2015, the GAD maximum limit is being removed and you will be able to take any amount out of the fund.
Provided you have at least £12,000 of secure income elsewhere, there is no limit to the amount of income you can take from your pension pot. Your £12,000 can come from your state pension, a final salary or other occupational pension scheme. As with any income from a drawdown plan, it will be taxed at your highest marginal tax rate.
These are changing from April 2015 and make this type of plan even more attractive to pensioners. Until April 2015, in the event of death, the surviving spouse can take any remaining pension fund as:
- A lump sum subject to a 55% tax charge, although this can be deferred until after April 2015
- A continuing income, taxable at their normal personal income tax rate or, use the remaining fund to buy a lifetime annuity, taxed at the usual personal income tax rate
*After April 2015 the 55% tax charge is being removed, the whole fund will then be available to the beneficiaries with no tax charge at all provided they are under 75 years old. If they are over 75, then tax is still payable however, the rules have yet to be confirmed
The Advantages and Disadvantages of Drawdown & Annuities
- Income is known at outset, guaranteed and secure
- Simple and easy to understand
- Not affected by downturn in investment markets
- Income is payable for life, however long that is
- Once set up, they cannot be altered
- Existing annuity rates are low
- Level income will lose its buying power over time
- Can be poor value if annuitant dies young
- Potential for growth as the remaining fund is invested
- Income levels can be very flexible to suit needs
- Remaining pension fund can be passed to beneficiaries on death
- Retain investment choice and control
- Income and fund value are not guaranteed and can go down
- Can be more complex and is likely to need advice
- The pension fund may run out if too much income is taken or the fund drops
- Drawdowns will need regular reviewing by a professional adviser