Pension Drawdown
The days when the proceeds of your pension plan must be used to buy an annuity have finished. 'Drawdown' allows the individual to flexibly access their pension in the most tax efficient way and one that suits their personal circumstances.
This may be in the form of withdrawing all the tax-free cash at outset and leaving the remaining funds invested or setting up regular payments made up of tax-free cash and taxable income.
Generally speaking, this method of decumulation is only suitable for people with pension plans in excess of £100,000 although this will depend on the plan, the charging structure and the exact circumstances of the individual. With annuity rates at a record low, more people are considering the use of all or some of their pension plans for drawdown.
How does pension drawdown work?
Your pension needs to be with a provider that offers drawdown. Drawdown is offered by a number of different providers.
You can decide how much of your pension you want to move into drawdown. You don’t have to put the whole of your fund into drawdown at one time and you can mix and match your options – setting up a drawdown fund with part of it and using the rest to provide a secure income through an annuity, for example. A lot will depend on how much income you need at different times in the future and what other income sources you have.
However you access your pension, you need to consider how long you want your retirement income to last and ensure that the level of income you have taken doesn’t impact future income needs.
How is drawdown income taxed?
Once the full tax-free lump sum has been taken, income from the drawdown fund is taxed at your marginal income rate. It is added to any income you have from other sources in the tax year for calculating the rate and amount of tax to be paid.
Taking any taxable income from your pension will restrict any further pension contributions to £4,000 per year. This is called the Money Purchase Annual Allowance (MPAA). This restriction does not apply if you take income within the capped drawdown rules.
Principal Advantages
- Tax Free Cash can be taken independently of pension income. Those still earning but wanting access to a lump sum can use drawdown in this way
- Flexibility - income can be turned on and off as required. This can be helpful for tax planning purposes for those with other assets or income
- People who suspect their health will deteriorate can draw income until an enhanced or impaired life annuity becomes available
- MortgagOpportunity to grow retirement benefits during drawdown should investments perform welle Advice
Principal Disadvantages
- If investment returns are not adequate, then the withdrawals would erode the plan value
- Investment into 'safer' asset classes such as gilts and cash are unlikely to generate the returns required
- Investment into assets that have the potential to generate the returns required to protect the underlying fund value carry additional risk and are not suitable for the short term
- Contract charges can be high on selected drawdown pension contracts
- Annuity rates might seem low now, but there is no guarantee that they will not be higher in the future
For an initial enquiry or a comprehensive financial review please email enquiries@pennymatters.co.uk
