Key facts about Income Drawdown
What exactly is Income Drawdown?
What does it cost?
What choices does Income Drawdown give me?
How much income can I have?
What happens if I die?
How long does it last?
So what are the advantages of Income Drawdown?
What are the risks?
I would describe myself as cautious is Income Drawdown right for me?
Can I still buy an Annuity for a secured income for life?
Income drawdown works differently to other retirement options. Once you reach age 55 up to 25% of your pension fund can be taken as a tax free cash lump sum at outset – you don’t have to take the maximum 25%, you could take it in stages if your prefer. The remaining 75% of your pension fund is invested and used to provide you with an income . You can invest in the same range of instruments as if you were in an ordinary Personal Pension or SIPP.
While an Annuity appears to have no explicit cost is this is not the case with an Income Drawdown. You will have set up costs to pay your Adviser and this could be as much as 7.5% of your total fund value. There will be annual charges levied by the Administrator of your scheme (usually an Insurance company) which could be anything from zero up to £695 per annum dependent upon your investments.
The same as if you were in a Personal Pension you will have Annual Management Charges on the funds in which you are invested, which will be 1%-2% per annum dependent upon your fund choice and you will more than likely have an annual fee to pay your Adviser (unless you are managing your investments yourself) for monitoring and managing your investment strategy and this will be determined by the service contract you have with your investor but usually ranges from 0.5%-1.5% per annum.
So why would anyone of sound mind want to pay all these additional costs? See below!
Unlike an Annuity where you make a choice at retirement and you are stuck with the consequences of it for the rest of your life, Income Drawdown allows you to keep your options open. Whilst you are in Income Drawdown;
- You have the option to take some or all of your tax free cash entitlement
- You have the ability to change your income amount as often as you choose
- You have a broad range of investments to choose from and can change them as often as you wish
- You have flexibility how your death benefits are paid
- You can elect to use part or all of your fund to purchase a secure income at anytime
Essentially you are not committed to any particular course of action and you can amend your Income Drawdown as your circumstances and aspirations change, which they surely will as time as time passes. For example your employment status will almost certainly change, as may your health or marital status, your rate of income tax or income requirements. All of these things can be addressed in Income Drawdown which has maximum choice and flexibility -but it is not without risk – see below!
The short answer is; As much as you want! Since April 2015 there is no upper limit on the amount of income you may take. Infact you could Drawdown all of your fund in a single income payment if you wish, although I wouldn’t advise it as you will pay income tax up to 45% on the whole amount!
Clearly the potential to take an income larger then if you purchased an Annuity is attractive and you don’t have to consider things like a spouse’s pension or protecting your income against inflation. However you need to consider how long your fund will last and what is a sustainable level of income for you to withdraw?
As a rough guideline you should not consider withdrawing more than 4% per year if you want your fund to last a lifetime.
You also have the flexibility to change your annual income as often as you wish. But – and this is a very BIG but (see What are the Risks?) if your fund value is falling and you are taking maximum income you are on a very slippery slope!
To put this simply if you fund is growing at 7% each year and you are taking an income of 5% your underlying fund is increasing in value (by 2% per annum) which means you can look forward to a larger income in the future. This is the beauty of Income Drawdown, all the choice and flexibility and an increasing income, what more could you ask for?
However if your fund falls in value by 7% you will be down 12% in a year. You do not need to be a mathematical genius to work out the long term consequences of too many years like that. You can of course secure a guaranteed income at anytime by purchasing an Annuity, but it may not be a good time to do so. For example Annuity rates could be at a market low.
‘Right!’ I hear you say ‘I am only going to invest where there is no risk such as Bank Deposits’. That’s fine but if the Bank are only paying you 3% (and let’s not forget perhaps 1.5% coming off your Pension plan in charges) and you want to take an income the sums simply don’t add up.
Be under no illusions, Income Drawdown is a high risk strategy and not one for the cautious or unsophisticated investor.
If you die your beneficiaries have three options:-
- Taking a cash lump sum
- Buying an annuity with the remaining fund.
- Continuing to take income drawdown
The tax treatment of your remaining Pension fund will depend upon the choices you make, the age you die and the choices your beneficiaries make. I would strongly advise that you take Professional advice prior to making any arrangements to avoid unnecessary payments to the Taxman.
How long does it last?
You may remain in Income Drawdown until you die but you always have the choice whether to purchase an Annuity, and after age 75 if you haven’t taken all of your tax free cash by that point it will be subject to tax.
- Allows you to receive all of your tax free cash lump sum at outset.
- Income can be varied which may assist in tax planning
- Your fund remains invested and therefore with good investment performance your ultimate pension income could be greater.
- Purchase of an annuity can be avoided indefinitely.
- On your death your family can benefit from the full value of your pension fund.
- There is no guarantee that your income will be as high as that offered under the compulsory purchase annuity or transfer route mentioned earlier.
- Annuity rates are not guaranteed and may increase or decrease in the future making Annuity purchase expensive compared to today’s rates.
- Future investment returns are unknown and the value of funds remaining invested in your personal pension will fluctuate over time. If the value of your pension fund falls you could receive a lower income in future years.
- You may withdraw too much income in the early years. If you pension fund does not grow sufficiently your income in the future may have to reduce and your fund could be eroded over time leaving you with very little or even no income.
- There are increased costs involved as ongoing reviews of your plan will be needed to ensure that your retirement needs are being met as your circumstances change.
- Under current legislation you will have to make a decision at age 75 whether to buy an annuity regardless of annuity rates at the time, or enter into Alternatively Secured Pension which may not be appropriate.
- The level of income you get from a conventional annuity is based on the average life expectancy if someone your age. A life company when fixing an annuity rate will take into account that the funds of those people who die early will remain in the pool to effectively subsidise those who live longer. This is known as “Mortality Gain”. Income Drawdown does not benefit from any subsidy.
No! Income Drawdown is a high risk investment strategy so be under no illusion of the risks involved, you need to be certain you are comfortable with those risks. Although you can of course purchase an Annuity at anytime, you do not want to pay the costs of establishing an Income Drawdown to then buy an Annuity in the near future!
Yes! You can purchase an Annuity with some or all of your fund at anytime and of course the older you get the better Annuity rate and in turn retirement income you will be able to obtain. It may be something you want to do gradually as with most people the older they get their appetite for investment risk tends to decrease.
Income Drawdown gives you more choices and greater freedom than any other form of pension income but at a price and that price is investment risk.