Income Drawdown

In simple terms, income drawdown is an alternative you have to buying a lifetime annuity when you reach retirement. It is also referred to these days as an unsecured pension. Income drawdown allows you to start drawing an income from your pension fund while the fund remains invested. It is usually relevant to those with larger pension funds; perhaps £100,000 or more, and with other assets.

The rules

What you can and can’t do

The government sets out rules as to the ways in which you can turn your pension fund into a regular income when you come to retire.

Normally, you take a tax-free cash lump sum and then use the rest of the fund to purchase an annuity from a life insurance company. This effectively turns your pension fund into annuity payments for the rest of your life.

However, you might decide that you don’t want to purchase a lifetime annuity straight away and therefore give yourself more flexibility. One option you have is an unsecured pension.

If you are under 75, an unsecured pension gives you an income from your pension fund by using income withdrawal or a short term annuity. The rest of your pension fund remains invested.

How it all works

Income levels

You can take up to 25% of your pension fund as tax-free cash. You start to take a regular or ad hoc income from what is left of your fund. This income is subject to tax.

There is a maximum level of income you can draw, but there is no minimum. The maximum is broadly equivalent to 120% of the amount you would get from a single-life lifetime annuity rate.

In the meantime, while you draw your income, the rest of the pension fund remains invested in a favourable tax environment. It is worth pointing out here that you will be taking an income from a fund that remains invested in asset-backed investments, such as the stock market, property, or gilts, therefore neither the value of the underlying fund or the income levels available from it are guaranteed and may go down as well as up.

Please note, should you opt to take the maximum income this will deplete your fund more quickly and may not be sustainable.

Five year reviews

To check income levels

The amount of income you withdraw must be reviewed every five years by your pension provider. This to ensure it continues to be set below the limits imposed by HMRC (HM Revenue and Customs). You can withdraw any income from your fund, provided it is below these limits.

You can stop the arrangement at any time and use your remaining fund to buy a short-term or lifetime annuity.

When you take out this form of contract the idea is that the invested fund grows sufficiently to pay for all or most of the charges, your income, and any mortality drag. However, the value of your fund could fall, and therefore you might have to take a lower income in future.

Changing Your Plan

You do have options

You can still make changes to your plan once you have chosen income withdrawal. You can:

■ Vary the amount of income.
■ Change the funds you have chosen to invest your pension fund in.
■ Stop the plan (as above).

When you reach age 75 you must either purchase an annuity or enter into an Alternatively Secured Pension (ASP) arrangement. ASP is a form of Drawdown and works in similar ways to an Unsecured Pension (USP) but has more restrictive income limits and death benefits. ASP is a particularly complex area of retirement planning and does warrant specialist advice from a consultant at AEGON Direct.

Your premature death

What happens if you die early

However, if you should die before reaching age 75, and you have not yet bought an annuity, your pension fund can be left to your partner and any dependants. They will have some annuity options, some more tax efficient than others.

The options

They could take some or all of the fund as a lump sum. This is taxable (currently @ 35%).

They could carry on withdrawing income, or they could buy a lifetime annuity with the whole fund.

Occupational schemes

Some allow income drawdown, some don’t

Some occupational pension schemes allow you to use income drawdown, some don’t. If yours doesn’t it may be appropriate to transfer your pension rights to a personal pension scheme first.

You should always seek financial advice before considering transferring any pension benefits, especially where these are from an occupational pension scheme and which could be a defined benefit arrangement.

In conclusion

Take advice

Income drawdown plans are complex, so it is important to get professional financial advice. They are not suitable for everyone, and are usually unsuitable if you have no other income or assets to fall back on, or if you have a smaller pension fund. Taking one out also depends on the amount of risk you are prepared to bear.

There are some new hybrid products in the market as alternatives to income drawdown plans should you not want the investment risks of income withdrawal, nor wish to commit to a lifetime annuity purchase. A variable annuity or a flexible annuity could provide you with an alternative solution.