An income drawdown plan is a type of personal pension.
It may be suitable if you want flexibility over the amount of income you take each year from your pension fund, and are prepared to leave your pension fund invested.
Under the option of an income drawdown pension you can choose to immediately take a tax-free cash lump sum and then have a further two options with regards to taking your income – capped drawdown and flexible drawdown.
Many people choose to take income drawdown because of the attractive flexibility of the death benefits, which can be passed to a spouse/civil partner or dependants.
Capped Income Drawdown Pension
An annual income can be taken from the invested pension fund, if required.
This income may vary between limits, set at outset by the Government Actuary’s Department (GAD). The maximum limit is reviewed every 3 years up until age 75 and then annually thereafter. The figure is derived from tables published by the Government Actuaries Dept (GAD) and is based on your fund size, age and the current gilt yield. This maximum current limit is 120% of a single life annuity that you could have purchased at that point. There is no minimum limit. Please note that Capped Drawdown Pension can be set up as a Phased Capped Drawdown plan. The difference under this option is that instead of buying an annuity to provide income, encashment of a certain portion of the fund would be made to purchase a series of Capped Drawdown Pension plans.
Flexible Income Drawdown Pension
There is no maximum limit with this type of plan allowing immediate access to the remaining funds.
You must be able to prove however, that you have a secured pension income already of at least £20,000 pa from other pension arrangements, to select this option.
The residual fund if taken in this manner would be subject to the usual income tax rates.
In order to use Flexible Drawdown Pension an individual must: –
- Satisfy the Minimum Income Requirement.
- Have paid no contributions (or had any contributions paid on their behalf) in the same tax year in which flexible drawdown is to be taken.
To be eligible the individual must also not be an active member of a defined benefit or cash balance scheme.
Whilst in Flexible Drawdown, any future contributions made into a money purchase scheme by the individual or their employer will be subject to an Annual Allowance tax charge taxed at the highest marginal rate, resulting in no financial gain. This tax charge will also apply to individuals who build up benefits in a Cash Balance or Defined Benefit arrangement.
If you die whilst in Income Drawdown Pension your spouse/civil partner/dependant has a number of different options available to them:
- he or she can take the fund as a cash lump sum (with a tax charge of 55%), or
- he or she can buy a lifetime annuity with the fund, or
- he or she can choose to continue taking Drawdown Pension.
There are no death benefits under Flexible Drawdown Pension if all the plan benefits are taken at outset.
Advantages of income drawdown plans
- You are able to take all of your tax-free cash lump sum entitlement at outset.
- You do not receive a set income but are able to vary it to suit your personal circumstances, up to a maximum limit, to supplement other sources of income or you have the option of taking it all at outset subject to meeting the minimum income requirement of £20,000 p.a.
- You are able to mitigate your liability to personal income tax in certain years.
- You have the potential to benefit from good investment performance in a tax-efficient environment and to exercise control over your own investment portfolio.
Disadvantages of income drawdown plans
- High income withdrawals may not be sustainable during the deferral period.
- Taking withdrawals may erode the capital value of the fund, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income when the annuity is eventually purchased and could also affect the long term financial security of your spouse/partner.
- The investment returns may be less than those shown in the illustrations that we provide to you.
- Annuity rates may be at a worse level when annuity purchase takes place. Although annuity rates generally increase with age, they have fallen dramatically during the past 15 years. This trend may continue.
- A careful investment portfolio needs to be constructed which will involve some investment risk. This means the fund value could fall which could affect your future income levels.
- Withdrawing too much income in early years may have an adverse effect on preserving your pension purchasing power or preserving the capital value of your fund.
- Increased flexibility brings increased costs and the need to review arrangements on an on-going basis.
- There is no guarantee that your future income will be as high as that offered by an annuity purchased today.
- You may feel the prospect of the future higher income does not compensate for the known income available from an annuity now and for the rest of your life.
- You may be prevented from withdrawing your chosen level of income due to the action of the GAD limits.