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What is Pension Drawdown and how does it work in 2020?

I’m sure you will agree that managing your finances after retirement can be daunting, which is why it is important to understand the options available to you.  

According to the Financial Conduct Authority (FCA), as many as 30% of consumers receive no guidance when taking out a pension drawdown policy.

We are here to help you understand the potential benefits and drawbacks are.

In this article, we will answer a number of questions related to drawdown, and how it may be suitable and potentially beneficial to your current situation. These include:

  •         What is pension drawdown – we provide a brief summary of the scheme and what it involves
  •         How does drawdown work – we show how it works in a simple manner
  •         When can you take pension drawdown from – we look at the age which you can take drawdown
  •         What the pension drawdown rules in 2020 are – we state the rules and conditions for drawdown including taking tax-free cash
  •         Are there income drawdown limits – we explore the limits to drawdown and how much you can withdraw
  •         Where can you take drawdown from – we provide advice on who are the most valuable pension drawdown providers

What is a drawdown pension?

Drawdown provides a method to use your current pension pot to allow a more consistent income after retirement. This works by reinvesting your pension pot into funds that are specifically designed to help you manage your retirement income.

The retirement income you receive will change depending on the performance of these funds, and so an income provided by drawdown, unlike a pension annuity, is not guaranteed to be available for life.

It is a complex product, and so it is important to understand the implications it may have for your financial security in the future.

This 2-minute video also provides a brief insight into how it works.

How does pension drawdown work?

Normally, you are able to choose to take up to a quarter (25%) of your pension pot as a tax-free lump sum.

With drawdown, your pension savings remain invested upon retirement, and you take money out of your pension pot through a flexible payment plan. Since your capital is invested, for example in the stock market, there is a possibility that your funds may decrease in value.

Money that isn’t withdrawn by you will remain invested, so although there is a chance your funds may decrease, there is also the possibility that investment growth can ultimately lead to your fund pot increasing in value.

This presents a potentially attractive option to over 55’s who may wish to invest their capital, with the possibility to see its value increase, for future enjoyment and financial security.

Though this is an intriguing concept you must consider the potential risk of having no secure income. This is why you need to take financial advice.

This method of retirement income, therefore, allows you to draw down on your pension pot, without having access to all of your savings at once. It also allows a combination of investing your funds to generate a retirement income, while providing the opportunity to withdraw lump sums from your pot.

There are two main types of drawdown available in 2020, these are:

Flexi-access drawdown

With flexi-access drawdown, you can take up to 25% of your pension tax-free, as a lump sum in one go or in blocks through your retirement. Whether you intend to use your money as retirement income, pay for your long-term care or fulfil a lifelong dream, it can be yours to spend however you wish.

Once you’ve taken your tax-free lump sum, the rest of your money can be left invested. This offers the opportunity for growth for your money, unlike an annuity which provides a guaranteed income whilst you are alive.

Uncrystallised Fund Pension Lump Sum (UFPLS)

In this arrangement, you do not take the 25% as a lump sum from the outset, but each time you withdraw some money, 25% will be tax-free, while the remaining 75% is subject to taxation.

Pension drawdown differs from an annuity since there is no guarantee to retirement income, and the value of your pot can increase or decrease depending on how well your investments perform.

Since annuity rates are historically low due to the economic environment, it may be able to offer a larger pension than an annuity, depending on your own circumstances.

pension lump sum

Pension Annuity vs Drawdown

See below for a brief comparison between buying an Annuity and Pension Drawdown:

Annuity

  • Buy a fixed income from the annuity provider
  • Family won’t receive any of your pot unless you pass away during a guarantee period
  • Income depends on age, health among other factors
  • Your income is guaranteed
  • No investment risk, your annuity is guaranteed for the rest of your life
  • An annuity is subject to income tax, should your total income surpass the income tax threshold

Pension Drawdown

  • Invest some of the funds and take a regular income
  • The family receive any money remaining in your pot – taxed if you die aged 75 and over
  • No restrictions on how much income you can withdraw from the pension fund
  • Income isn’t guaranteed, you can only take an income as long as there is money in the pension pot
  • There is an investment risk – your pot could decrease in value depending on investment performance
  • 25% available as tax-free cash, all other income is taken directly from the fund is subject to tax

When can you take pension drawdown from?

For the majority of people seeking to join any scheme, you have to be 55 or over before you can access your pension pot, and this includes through drawdown.  Therefore, this can work if you are looking for early retirement

There are however a small number of schemes that provide early access prior to turning 55, for instance as a result of ill health, so it is recommended that you check with your pension provider.

There is no upper age limit for starting, so it is never too late to consider starting to manage your post-retirement income in this way.

What are the pension drawdown rules in 2020?

Prior to the pension reforms of 2015, an individual could take it using either a capped or flexible method.

Under capped income drawdown, a person could draw down a maximum of 150% of their pension pot, while under a flexible income there was no limit on the amount you could draw from the fund as an income, as long as there was a secure gross income of at least £12,000 per annum.

If you were in capped drawdown before April 2015, you can continue with this even with the introduction of flexible income drawdown. If you do want to switch to the flexible method, you may be able to draw more than the cap, automatically converting the capped to a flexible drawdown.

From April 2015 onwards, all new arrangements are classed as being ‘flexi-access’. The rules for this include:

  1.   The earliest age you can access the benefits of drawdown is 55, or earlier if you are suffering from ill-health.
  2.   You can take out as much or as little from your pot as you wish, meaning you do no thave to meet any pre April-2015 restrictions on capped or flexible drawdown.
  3.   You can still accumulate the benefits of another pension scheme, for instance, a defined benefit or defined contribution scheme.
  4.   You must be aware of the changes in the Annual Allowance rules before you begin to withdraw funds.

This BBC article compares Annuity and Pension Drawdown following the 2015 reforms, and provides useful information and guidance to those considering their pension arrangements:

Your pension provider is not legally obliged to offer flexi-access drawdown. If your provider is not currently offering this or is not looking to offer this in the future, you must find out whether you can transfer any benefits to another provider.

If you choose to take a pension transfer to a new  provider, you should seek independent financial advice from someone authorised by the Financial Conduct Authority (FCA).

By receiving financial advice, you can identify providers who may offer a pension policy suitable to you, as well as weigh up the pros and cons based on your own personal circumstances.

If you do start taking a retirement income, under the money purchase pension allowance rules, you are able to continue to pay £4,000 each year into a pension. If you do pay £4,000 in you can still receive tax relief on your pension contributions.  

If you need assistance to locate a financial adviser local to you, you can find one here.

draw down pension

 

What tax will you pay?

Moving your savings into income drawdown is a straightforward process, although it is essential that the initial process is completed correctly as there could be taxation implications further down the line.

Taxation is considered the most complicated aspect of choosing to take your pension down this route.

Any income taken from drawdown is taxable within that tax year, alongside any other regular income. This includes all pension income, and all other earnings including employment earnings, dividends and rental income, though it is worth noting that you can take tax-free cash of 25%.

It is also worth taking into noting that larger withdrawals from your pension pot could push you into a higher tax band, so this is a worthy consideration when deciding how much to withdraw and how often.

Here is a potential tax paying scenario you may encounter under a pension drawdown policy:

  • If you withdrew £50,000 and were receiving no other regular income from any private pension, employment earnings or rental income, you would be taxed £7,500, following the £12,500 taxfree withdrawal.

There may be some tax to be paid on a drawdown pension if you die over the age of 75. However, if you die before turning 75, your beneficiaries shouldn’t have to pay any tax on the inherited capital.

For more information, visit the ‘Which?’ guide to Tax on pensions, to access a pension tax calculator.

Are there income drawdown limits?

You are able to take money out of a Drawdown Pension as often as you want, when you want, although this depends on your provider’s rules. However, there may be incurred charges for each withdrawal made, so it is important to check with your provider’s regulations concerning this.

Fees and charges can often trip you up if you do not thoroughly check when comparing drawdown providers and which is most suitable for you.

 This Guardian article suggests that many British citizens aren’t currently saving enough to have a comfortable retirement, putting into perspective the importance of researching and choosing a suitable policy for your own circumstances.

flexible drawdown pension

 

Where can you take pension drawdown from?

Deciding on a pension provider that is suitable for your needs can be difficult, and requires some background research before committing to an arrangement. Since Pension Drawdown is complex and not suitable for everyone, it is essential that you understand the risks and costs before transferring your pension fund.

Money’, a pension comparison site, has compiled a list of the 5 most popular Drawdown pension providers:

  1.   PensionBee
  2.   AJ Bell Youinvest Pension
  3.   Hargeaves Lansdown Pension
  4.   True Potential
  5.   True Potential Investor Pension

By accessing potential providers, you can assess their suitability for your own circumstance, which can be assisted through seeking advice from the FCA, as well as gaining an understanding of any fees and charges. It is also the role of a financial advisor to recommend the policy most beneficial to you.

Due to the precarious nature of investing your pension and the ability to withdraw as much as you want when you want, you should carefully plan how much you can afford to take under drawdown, otherwise, you may risk running out of money. This could happen if:

  •         You live longer than expected
  •         You withdraw too much of your pension without planning for the future
  •         The investments you have put money into don’t increase in value as you had expected and you take more out than you are gaining from investments.

It is important to review all of your investments, to ensure you aren’t losing capital in the future and to ensure you have financial security.

Pension drawdown is not the only retirement income option available to you, and there is no need to worry if the scheme is not suitable for your current financial system.