When can I drawdown my pension?
From the age of 55, individuals can take out their pensions in drawdown. In some cases, if an occupational scheme has a protected retirement age that is lower than 55, it may be possible to withdraw funds earlier. Additionally, early access could be granted in situations where one’s health is compromised.
Can I take my tax-free cash lump sum without having to take an income?
Yes, is the short answer. This is one of the main advantages of drawdown, it allows you the flexibility to take an income and/or tax-free cash to suit your needs.
Some people want to take tax-free cash from 55 but continue to work. The main idea behind this is to pay off a mortgage or other debt, thus reducing ongoing expenditure and freeing up disposable income.
Beware, however, as once you’ve used your 25% tax-free cash allowance, no further tax-free lump sum can be taking when you do eventually stop working.
How do I know which provider to choose?
Many pension schemes that help you save during your working years, will also offer a drawdown facility. For those that do, this might be an easy transition into drawdown, but be warned, often not the most cost-effective.
The best way to find a drawdown provider is to do your homework. Think about what you want to do with your fund.
Do you want to invest in a wide range of investments from across the market and trade regularly?
Do you need online access to view and change your portfolio?
Do you want someone to pick your funds for you?
Do you want to keep ongoing costs to a minimum, even at the expense of potential performance?
Do you want a simple strategy?
Do you prefer a household name pension provider, or are you willing to look at other providers who may offer lower costs?
There are over 100 providers of drawdown and over 10,000 funds to choose from. If you are confident of managing this yourself, great. If you don’t have any experience of managing investments, speak to a financial adviser.
How do I know how much money to take out each year so that it lasts?
This is the 64-million-dollar question. The best way to answer this is to plan.
Work out all your expected monthly outgoing in retirement together with your expected income (such as state pensions). The difference between your other income and your expenditure is the amount you need to make up by taking withdrawals from drawdown.
If you take too much each month and live a long retirement, or your fund doesn’t perform, you may run out of funds.
At the outset, it’s important to understand how much money you’ll need and plan this out. If you’re using a financial adviser, they should do this with you in the form of a cashflow forecast.
How is the income taxed from drawdown?
Apart from the 25% tax-free allowance, all the other income withdrawn is taxed as earned income. Therefore, the total income you receive from state pensions, other annuity income or rental income, will be added together with the income taken from drawdown to determine how much income tax you owe.
If you take large lump sums, say of £10,000, you may be overtaxed initially, until HMRC understand that this was a one-off withdrawal and make a tax-rebate. There are ways to claim this tax back earlier using some HMRC forms.
Do I have to take the full 25% tax-free cash all at once?
No, your total allowance to take free cash is 25%, but this can be taken in stages. You could therefore take 10% initially and 15% in 5 years’ time as an example.
There could be an advantage to staggering you tax-free cash. Let’s look at an example.
£400,000 pension pot.
Person A takes their full 25% at the outset. 25% of £400,000 is £100,000.
The total tax-free cash this person has can never be more than £100,000 as they’ve used all their allowance at the start.
£400,000 pension pot
Person B takes 10% which equates to £40,000 tax-free cash. Their used allowance is 15%.
If £40,000 was taken from the pot, there is £360,000 left invested.
If in 5 years’ time the £360,000 pot has grown to £450,000, person B can then 15% of this total.
15% of £450,000 is £67,500.
Therefore, their first 10% withdrawal of £40,000 plus their second 15% withdrawal of £67,500, totals £107,500.
Person B has managed to withdraw £7,500 more tax-free cash than Person A, by staggering their withdrawals.
What are the costs to set drawdown up?
There is usually some cost to set up a drawdown plan.
These could be dependent on how many plans you are consolidating in to one drawdown arrangement and what type where you intend to invest your funds.
The usual set up costs are up to £300, but some schemes change per additional pension transferred in.
If you use a financial adviser, there may be no set up costs, as advisers have access to plans not available to the public, however there will be initial advice cost levied by the adviser.
What is the ongoing cost to run a drawdown plan?
Each provider has a different way of charging for drawdown and it’s one bugbear of not being able to easily compare them.
What you pay for your drawdown plan should be determined by how your going to invest.
If you want a simple plan there are some providers who offer a limited range of funds and a simple charging structure. Royal London is a good example. Solely available to financial advisers and their client, Royal London run their own funds and therefore have a simple, and low-cost charging structure. A risk-rated portfolio can be used for around 0.5%, plus any charge you may pay to the financial adviser for ongoing management.
If you’re investing yourself, you need to think about whether you’re just going to invest in funds or other investments such as individual shares and property, as these often come with additional ongoing costs.
Many of the well know pension providers offer drawdown through a personal pension arrangement however there are many SIPP (self-invested personal pension) providers who offer drawdown, and who can often be cheaper to run.
On top of the provider’s charges there are the ongoing charges for the funds that you place in the portfolio, often referred to as annual management charges.
Typically, if your managing your own portfolio, the total charges can range from 0.4% to 2% per annum.
If you’re using an adviser this could be from 1% to 2.5% per annum.
The additional premium you pay for advice, in theory, should provide you with additional growth and a more suitable investment.
Do I have to stay with the same provider once in drawdown?
No, you can change providers whenever you wish. You aren’t ‘locked in’ for any term. If you’re seeking financial advice and they express a ‘lock in’ period, this is a red flag.
Some providers may charge a small admin fee if you change out of their plan within the first 2 years, but this shouldn’t be more than £200.
Additionally, if you wish to buy an annuity at some point in the future, this is possible using some or all of your funds in drawdown.
What happens if I die in drawdown?
Any remaining fund will be passed onto your estate. You should ensure that you have completed an ‘expression of wish form’ when setting up the plan, and also keep this updated by making changes as you see fit throughout your retirement.
What are the tax implications on death within drawdown?
If you die before age 75, the fund passes to your named beneficiaries without any tax liability and they can withdraw their funds without any tax liability.
If you die after 75, the funds pass to your named beneficiaries without any tax liability, but, when they make withdrawals, it will be added to their own income and taxed accordingly.
How can I take my money out of drawdown?
You can choose to take your money out of drawdown the way that suits you. You can either set up a monthly regular income or take one off lump sums whenever you wish.
Be aware, however, that it’s not as instant as a bank withdrawal. The funds have to be sold down and the paid, which usually takes around 2-4 weeks from the withdrawal request.
Some companies have a payment date, for example the 1st of the month, in which case you’ll need to let them know by a certain cutoff date, other, can pay at any point in the month.
How do I know what level of risk to take with my funds in drawdown?
If you’re an experienced investor and want to manage your own drawdown pension, you should already know which funds are more volatile than others.
If you are inexperienced and want to take financial advice, your adviser will take you through a risk profile questionnaire together with discussing things such as your capacity for loss. This will determine the type of portfolio they will recommend for you.
There are no right or wrong risk levels, it’s all about how comfortable you feel with volatility and how much you can tolerate a reduction in your portfolio. If this is your sole retirement pot you may be more cautious where as if you have other income and aren’t reliant on this drawdown pot, you may be comfortable taking more risk.
Equally if you have a large pot and intend to take out a modest income, you could afford for more volatility. Everyone’s situation and objective are unique to them and so there isn’t a ‘perfect’ portfolio for all.