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 if and when you wish.
What does it cost?
You will have set up costs to pay your adviser and this could be as much as 5% of your total fund value plus there will be annual charges levied by the adviser and manager of your funds which could be anywhere from 1-3% per annum.
What choices does income drawdown give me?
- You have the option to take some or all of your tax free cash
- You have the ability to change your income as you choose
- You have a broad range of investments to choose from
- 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 passes.
How much income can I have?
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%.
Clearly the potential to take an income larger than 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.
As a rough guideline you should not consider withdrawing more than 4% per year if you want your fund to last.
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 income you are on a very slippery slope!
To put this simply if you fund is growing at 7% net and you are drawing 5% income 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% and you are drawing 5% income 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.
‘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 is only paying you 1%-2% (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. That’s before we consider inflation of 2-3% eating away at the value of your fund
Be under no illusions, income drawdown is a high risk strategy and not one for the cautious or unsophisticated investor.
What happens if I die?
If you die your beneficiaries have three options:-
- Taking a cash lump sum
- Buying an annuity with the remaining fund.
- Continue income drawdown
The tax treatment of your remaining Pension fund will depend upon the choices you make, the age you die and your choice of beneficiaries. 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 and you always have the option to purchase an Annuity. After age 75 if you haven’t taken all of your tax free cash, it will be subject to tax.
So what are the advantages of income drawdown?
- 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 a lump sum.
What are the risks?
- There is no guarantee that your income will be as high as that offered under the annuity route.
- 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 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.
I would describe myself as cautious is income drawdown right for me?
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!
Can I still buy an Annuity for a secure income for life?
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.
Income drawdown gives you more choices and greater freedom than any other form of pension income but at a price and that price is RISK.