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 of the Pension Drawdown scheme.
In this article we will answer a number of questions related to pension drawdown, and how it may be suitable and potentially beneficial to your current situation. These include:
A drawdown pension 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 income.
The income you receive will change depending on the performance of these funds, and so an income provided by pension drawdown is not guaranteed to be available for life. Pension drawdown 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 from PensionBee also provides a brief insight to drawdown.
Normally, you are able to choose to take up to a quarter (25%) of your pension pot as a tax-free sum. Depending on your pension provider, you may be able to take more than 25%.
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Money that isn’t withdrawn will remain invested, so although there is a chance your funds may decrease, there is also the possibility that investment growth can ultimately lead to your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 pension drawdown as 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 method of income drawdown, therefore, allows you to draw down on your pension, without having access to all of your savings at once. It also allows a combination of investing your funds to generate an income, while providing the opportunity to withdraw lump sums from your pot.
There are two main types of drawdown available in 2019, these are:
In this arrangement you are able to take out 25% of your funds as a tax-free lump sum from the outset, however, if this is not taken out from the outset, you won’t be able to do so at a later date. If you take the lump sum, you cannot receive income for some time, or until you require to withdraw down payments, and any income withdrawn is subject to taxation.
In this arrangement, you do not take the 25% as a lump sum from the outset, but each time you withdraw a payment, 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 income, and the value of your pension pot can increase or decrease depending on how well your investments perform. Since annuity currently lies at historically low rates due to economic pressures, pension drawdown may be able to offer a larger pension than an annuity, depending on your own circumstances.
See the table below for a brief comparison between Annuity and Pension Drawdown:
For the majority of people seeking to join any pension scheme, you have to be 55 or over before you can access your pension pot, and this includes through pension drawdown.
There are however a small number of pension 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 a drawdown pension, so it is never too late to consider starting to manage your post-retirement income in this way.
Prior to the pension reforms of 2015, an individual could take drawdown in either a capped or flexible method.
Under capped income drawdown, a person could draw down a maximum of 150% of their pension, 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 a 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 drawdown to a flexible drawdown.
From April 2015 onwards, all new drawdown pension arrangements are classed as being ‘flexi-access’. The rules for this new drawdown include:
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 pension provider.
If you choose to take a pension transfer to a new pension 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 need assistance to locate a financial adviser local to you, the money advice site can help.
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 on pension drawdown is considered the most complicated aspect of choosing to take your pension down this route.
Any income taken from the drawdown scheme is taxable within that tax year, alongside any other income. This includes all pension income, and all other earnings including employment earnings, dividends and rental income, though it is worth noting that the first 25% withdrawn is tax-free.
It is also worth taking into noting that larger withdrawals from your pension 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:
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.
You are able to take money out of a Drawdown Pension as often as you want, when you want, although this depends on your pension 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.
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 provider.
‘Money’, a pension comparison site, has compiled a list of the 5 most popular Drawdown pension providers:
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:
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.