In April 2015, flexi-access drawdown or pension drawdown as it’s sometimes known, became the product of choice for many retirees. Traditionally people used their pension fund to purchase an annuity, which is a guaranteed lifetime income, however, new rules announced by the chancellor George Osborne, are more geared towards flexi access drawdown, which provides more flexibility.
Flexi-access drawdown explained
Much like your pension fund is invested in funds in the accumulation stage, flexi access drawdown keeps it invested, but with the added benefit you can take an income from it. The pension pot essentially stays in your hands rather than an insurance companies, as with an annuity. You therefore have complete flexibility and control to take an income from is as you please.
Clearly having full access to your hard earned savings is a step in the right direction. There has always been a stigma with pensions that you might not get out what you put in. For example with an annuity if you died early the annuity company would tend to keep the remaining fund. Therefore it was always thought that you’d need to live a long time to get value from your savings.
The new rules allow complete access and flexibility to your pension savings. Therefore the advantage come when you might for example need to take out more in a particular year than say an annuity would have given you. This may be to pay off a mortgage on retirement, clear loans or pay for your daughters wedding. Equally if your health isn’t perfect, you may wish to enjoy yourself and your money whilst you still can.
With income drawdown the assets can be enjoyed by yourself whilst you are alive but now also passed onto your estate on death. Income drawdown was introduced in 1995 and always allowed for the funds to pass between spouses without a ‘death tax’, it was therefore useable by the surviving member, providing one of the main reasons it has traditionally been used. The problem lied on the death of the 2nd spouse and prior to April 2015 is was taxed at 55% when passed to the children for example. The new pension rules are removing this 55% death tax. Because it’s a pension it will not fall into the estate for inheritance tax either. The rules have therefore created essentially a family trust which can be passed down from generation to generation without a death tax added.
Death Tax Summary
If you die before age 75
|Pension Drawdown lump sum
|Tax free if passed between spouses and spouse buys a pension income i.e. an annuity or income drawdownSubject to 55% taken by spouse and put in a bank account (doesn’t buy a pension income). Also taxed if passed to dependants.
If you die after age 75
|Pension drawdown lump sum
|Subject to 55% tax
|Subject to 55% death tax if payment made before 6th April 2016. 45% if paid between 6th April 2015 & 6th April 2016After 6th April 2016 – only tax if the beneficiary wants to take income out at which point it will be taxed against their earned income
Annuities don’t offer flexible access to your pension fund but their do provide the peace of mind of a guaranteed lifetime income. Income drawdown does not. If you take out large lump sums and the fund doesn’t perform to replace it and/or you live longer than expected your fund could run out. It is therefore vital to plan the income withdrawals.
Your money will in most cases stay invested and exposed to market risk. The value of the fund could therefore go down as well as up. If you aren’t used to investments or have limited experience of them, this could provide a nasty surprise if markets don’t perform.
Where is your money invested?
There are thousands of potential investment funds your money could be invested into. It’s importance to understand the risk associated with your pension drawdown investment. There is no right or wrong answer with the amount of risk you are prepared to take, it’s you money and therefore you should pick investments that intend to perform as you expect.
You money will generally be pooled with lots of other people and professionally invested on your behalf. The advantage of this is to spread or mitigate risk as much as possible. Fund manager with look for investment opportunities in the areas they specialise. This could be globally, UK based or in a specific sector such as technology. You should carry out a risk assessment on yourself or with the help of a financial adviser before deciding which funds to go for.
Who provides income drawdown?
There are many companies who offer the facility of income drawdown, as there are many companies that offer annuities. Choosing a pension drawdown provider need a little more consideration than annuities however. With annuities it’s quite obvious which provider to go for, the one offering the highest income. With drawdown however, considerations need to be given to the associated charges, ability to view your fund online and choice of investments to name three. This will come down to personal preference. Some people prefer well know names such as Standard Life or Aviva, others want to access the facilities of drawdown but at the cheapest cost. It’s very much horses for courses in this respect.
What are the charges?
There are additional ongoing cost associated with income drawdown as your plan is professionally managed. The main three charges could be.
- Annual management charge. This is the fee the fund managers will take to professionally invest your money. This can vary widely depending on the type of management style or fund you go into.
- Platform/SIPP charge. This is the ongoing cost to administer your plan. For example if your drawdown plan is with Aviva, they will take an ongoing percentage to provider ongoing administration
- Adviser charge. If you take financial advice to set the plan up, a financial adviser will usually levy an ongoing charge to ensure your plan stays invested according to your ongoing requirements. They can provide advice on fund switches, regulatory changes and give guidance on a sensible amount to withdraw to ensure sustainability.
These charges can vary widely depending on provider/fund choice and financial adviser used. Drawdown tends to become more cost effective the larger the pension fund. Prior to April 2015 and the new pension freedom reforms, drawdown was usually only considered for pots of £100,000 and above. Providers have now lowered the entry level to £30,000 in some instances in light of the expected increase demand for the product.
Pension drawdown will provide the flexibility many have been craving for years. They will reignite the appetite to save into a pension which has been lost on a generation. If you are considering drawdown, ensure you fully understand the features and risks involved.