Pension income drawdown is available to any person aged 55 or over who has defined contribution benefits. Pension income drawdown is a way of taking money directly from your pension pot for your retirement needs. It contrasts with using money from your pension fund to buy annuity income from an insurance company.
Keeping your pension fund invested
When you take pension drawdown, your residual private pension investments stay invested, in the strategy of your choice. While this means they can continue to grow over time, there's always a risk your fund may fall in value.
Although pension income drawdown could potentially reward you with higher returns in the longer-term, there remains a chance that your fund will shrink and cause a reduction in your overall retirement income. However, we have observed that over longer periods the stock market has provided positive returns historically. Periods of volatility in the equity market are inevitable, but as long as you have the time to weather these storms, and depending on your long-term goals, potential lifespan and personal situation, pension income drawdown may be a viable option to consider.
Pension income drawdown may be the best option for you if:
However, you may wish to avoid remaining invested if:
To determine whether a pension income drawdown plan is the right approach for you and your pension savings, it may help to seek advice.
People who took out a pension drawdown before 6 April 2015 were able to access something called capped drawdown. Although capped drawdown is no longer available to new applicants, those already in a capped scheme can continue to retain their existing arrangements.
There is a limit on how much can be taken from the capped drawdown pension in any one year; this is imposed by the Government Actuary Department (GAD). Withdrawals can’t exceed this government set limit, but the amount of income taken can vary from one year to the next. If the maximum income is not taken in a single pension year, the difference can’t be taken in a later pension year. Limits are reviewed every three years for those aged 74 and under, and annually once age 75 is reached. Reviews are used to calculate a new maximum income for the next period. Capped Drawdown policy holders can transfer their benefits to a Flexi Access Drawdown pension to remove these income restrictions, if desired.
Flexi-access drawdown usually allows you to take up to 25% of your pension pot as a tax-free lump sum.
Any remaining savings can remain invested in line with your desired strategy and then withdrawn at a time that suits you and your income objectives. The amount of cash flows you can take will vary depending on how well your portfolio performs and other factors.
You can choose to take your income as soon as you have taken your tax-free lump sum or you can delay the point at which you begin to receive taxable payments. Additionally, there is no need to draw all of your tax free cash at one time. Your tax free cash entitlement can be drawn as needed.
Flexi-drawdown is a popular form of pension income drawdown because it allows retirement investors to move their pension pots into income drawdown in stages. It also offers further flexibility—for example, savers are able to use all or some of their income drawdown to buy other types of retirement income products. However, the tax implications of a flexi-drawdown can be complex. It may help to consult a professional to decide if this option might be suitable for your income needs.
Plan your retirement
It is important to speak with your financial adviser about how to best plan your pension income strategy in line with your retirement objectives. This can help you avoid running out of money if you live longer than you expect, have unplanned medical or care expenses, or you need to withdraw more than you should during the earlier stages of your retirement.
You should also seek advice on how to minimise the tax liability when making pension withdrawals. This is because any taxable money withdrawn from your pension pot is added to your other income for the year and taxed in the normal way. As such, large taxable withdrawals should be planned carefully—they qualify as income and have the potential to place you in a higher tax band.
Tax relief on future contributions is another important consideration. Once you begin to receive income from a flexi-access drawdown scheme, tax relief on any pension contributions is limited by the Money Purchase Annual Allowance (MPAA). Having taken a taxable pension withdrawal, the maximum gross pension contribution on which you will receive tax relief for the 2018-19 tax year is £4,000.
Defined benefit or defined contribution?
There are two major types of workplace pension: defined benefit and defined contribution. In a defined benefit scheme the benefits received depend on the earnings, length of service and accrual rate of the scheme. This generally means that those who have paid into the scheme for longer and/or have a higher salary receive the more generous benefits.
More and more employers are choosing to offer defined contribution pensions as part of an employees remuneration package as opposed to defined benefit schemes due to the unknown costs associated with them. Some employers allow existing members of defined benefit schemes to continue to build benefits within the scheme whereas others close the schemes to new and existing members. Nowadays, defined benefit schemes tend to only be offered to new members by the public sector and some very large private sector employers.
The demise of the defined benefit scheme has resulted in increased uptake of defined contribution schemes, where regular payments are invested by the pension provider and the size of the pension pot depends on the performance of the underlying investments. Other factors influencing the size of the pension pot include:
charges imposed by your pension provider
Before embarking on any pension drawdown plan it is important to understand your personal pension plan and how your pension pot is made up.
Accounting for your flexible income and cash flow needs
Once you reach 55, you can choose how to use your defined contribution scheme to create retirement income. One option is to take a lump sum withdrawal from your fund—either all or part of it; however, bear in mind that you can only take up to 25% of the pot tax-free.
An annuity may sometimes be the choice for some risk-averse retirees. Others may choose to convert their defined contribution fund into a combination of these retirement vehicles.
What you choose will depend on your needs, retirement goals and tax considerations. It is important to understand the ramifications of income tax, and what might happen if, for instance, you suffer ill-health or other circumstances as a pensioner which might unexpectedly put a strain on your retirement savings. This is why speaking to a financial adviser is so important when making personal pension decisions.
Help planning your pension withdrawals from Fisher Investments UK
It is important to decide what you will do with your pension once you reach retirement. However, making a choice between pension income drawdown, an annuity and a single lump sum withdrawal is not the only question you will face. For example, you will have to consider how you manage your wealth in such a way as to give you the best chance of having enough money to safely make withdrawals that adequately meet your financial needs.
Fisher Investments UK may be able to help you negotiate all the important retirement questions with financial advice tailored to their specific needs and with their individual pension schemes in mind. We may also be able to help you understand your options relating to your whole pension entitlement; that's state pension, personal pensions, workplace pensions and stakeholder pensions. If you are unsure about how much income your retirement savings will generate and how much your taxable income and allowances will be, we can help.