All about Income Drawdown
This article explains the pros and cons of Income Drawdown and what this could mean for your retirement planning under the new pension freedom rules.
Income Drawdown is a way of providing your retirement income without sacrificing control over your investments:
- Your retirement fund will continue to be invested and any retirement income you decide to take will come directly from your fund.
- There is no need to draw any income – making it an attractive option for people who need to access their tax free cash to meet a capital expense, but do not require the taxable income which would be provided by an annuity.
- Income Drawdown provides flexibility about how and when you receive retirement income. You can use your fund to purchase an annuity at a later date when you this is more appropriate for you.
- The death benefits available through an Income Drawdown pension are more flexible than through an annuity. This flexibility comes at the expense of ongoing charges and continued investment risk.
- An Income Drawdown plan does not normally provide a guaranteed income for life; by remaining invested your income could potentially increase, but if your investments do not perform as expected your income could reduce or in extreme circumstances stop.
Pension Freedom
Under the new pension freedom rules, all the limits on how much money you can withdraw from your pension have been removed. You can draw out your whole pension fund is one lump sum if you wish. This is not usually a good idea as you have to pay income tax on the withdrawal (excluding the 25% tax free lump sum). In order to calculate the Income Tax due, the withdrawal is added to your annual income which can mean you pay tax at the 40% (or even 45%) rate, even if you are usually a basic rate taxpayer.
…if your investments do not perform as expected your income could reduce or in extreme circumstances stop.
If you are considering drawing money from your pension it’s really important to speak to an adviser to ensure you do not face an unexpected tax bill and you have enough money to live on throughout your retirement. Many people underestimate their life expectancy, which means they risk running out of money in old age.
Death benefits
If you die with funds left in your Income Drawdown plan, the death benefits available to your loved ones will depend on whether you were 75 or over.
Before 75
- Any beneficiary can inherit the remaining fund as a tax free lump sum
- A dependant can continue with drawdown or use the fund to purchase an annuity. They will not usually be taxed on this income.
After 75
- Any beneficiary can inherit some or all of the fund as a lump sum. Under current rules there will be a 45% tax charge, but from April 2016 this changes. The inherited fund will be added to their own income and taxed at the appropriate rate.
- A dependant or beneficiary can continue to drawdown income or purchase an annuity and pay tax at the rate applicable to them.
Pros & Cons of Income Drawdown
Pros
- Timing – You can to choose when to purchase an annuity and may be able to benefit from improved rates.
- Flexibility – You can vary the amount of income you take and potentially control your Income Tax liability.
- Investment control – You can continue to make investment decisions with regard to your attitude to risk and investment needs.
- Death benefits – You can leave your fund to nominated beneficiaries
Cons
- Timing – Annuity rates may worsen rather than improve, or may not improve sufficiently to make up for years in which you have not received this income.
- Mortality drag – Annuity rates take into account the fact that some people will die earlier than statistically expected (this is called mortality cross subsidy). If you use Income Drawdown to delay purchasing an annuity the effect of mortality cross subsidy will be reduced and you would need to achieve a higher return whilst in Income Drawdown to counteract this (this is known as mortality drag).
- Investment risk – The value of your fund is not guaranteed and may go down as well as up. The value may not grow sufficiently to provide an income that matches that which you would have secured by purchasing an annuity.
- Income – High income withdrawals are likely to be unsustainable and this may reduce the financial security of you and your dependents in the long term.
- Review – Your fund and investment selections will need to be monitored and reviewed periodically to ensure investment performance remains on track.
- Charges – Your fund will subject to charges to cover administration and fund management. These are likely to be higher than a standard personal pension as the policy must be reviewed regularly and income payments administered.
