What is Income Drawdown
Drawdown (other terms often used are; Income Withdrawal or Income Drawdown) is an alternative to buying a lifetime annuity when you retire.
It allows you to draw an income from your pension fund while the fund remains invested.
Your pension fund
There are several ways of turning your pension fund into a regular income for your retirement. The government sets rules about how you can do this. The usual way is to take a tax-free lump sum and then use the rest of the fund to buy a lifetime annuity from a life insurance company. This turns your pension fund into a pension income for the rest of your life.
But if you decide you don’t want to buy a lifetime annuity straight away, one option is an unsecured pension.
We use ‘retirement’ to mean the time from when you start to take your pension benefits. If you have a personal or stakeholder pension, you could do this from age 55. If you’re not sure when you can start to take your pension benefits, check with your pension provider. You don’t have to stop work to start getting your pension.
How Income Drawdown Works
You can take up to 25% of your pension fund as a tax-free lump sum. You then draw a regular income from what is left and this is subject to tax.
Meanwhile, the rest of your pension fund stays invested in a favourable tax environment. Bear in mind 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.
Every three years, your pension provider must review the amount of income you withdraw. This amount must be set below the limit set by HM Revenue & Customs (HMRC). Your pension provider calculates this limit, using the standard tables prepared by the Government Actuary’s Department.
You can withdraw any income from your fund, as long as it’s below this limit. If your pension provider calculates that the new limit is lower than before, you may have to draw a smaller income to keep within this limit.
Some investors may be able to remove the cap on their income by applying for Flexible Drawdown
What are the risks?
The hope is that your invested fund grows enough to pay for all or most of the charges, any mortality drag and your income.
But if investment returns are lower than expected, your fund may fall in value. This may mean you receive a lower income in future. As you don’t have to draw an income from your pension fund straight away, you may be tempted to use Income Drawdown if you need a cash lump sum for a one-off expense. Before you do this, get professional advice and find out the risks.
- the fund could fall (as well as rise);
- you may have to pay set-up and annual charges on the investments in your fund; and
- if the income you take plus these charges exceed any growth in your fund, the value of your fund will decrease.
Three years is a long time, so you and your adviser should also review your Income Drawdown plan each year to check that your fund is growing enough to make up for the income you’re taking from it. You can stop the arrangement at any time and use your remaining fund to buy a short-term or lifetime annuity.
Changing or transferring your Income Drawdown plan
Once you’ve chosen Income Drawdown, you can still make the following changes. You can:
- vary the amount of income you withdraw;
- change the funds your pension is invested in; and
- stop the plan at any time and buy a lifetime annuity with the rest of your fund.
It is possible to transfer your plan but be aware that not all providers accept transfers. You may also be charged for transferring it, and the provider may set conditions that you have to meet before and after transfer. If you die and haven’t yet bought an annuity, you can leave your pension fund to your partner and any dependants. They will have various options, some more highly taxed than others.
These options include:
- taking some or all of the remaining fund as a lump sum, which is taxable, currently at 55%;
- carrying on withdrawing income; or
- buying a lifetime annuity with the whole fund.
- Converting your pension fund into income
Occupational money purchase scheme
You may be able to use Income Drawdown if you are in an occupational money purchase scheme – check with your scheme.
If you’re in a scheme that doesn’t offer Pension Drawdown but you want this, you can transfer your pension rights to a personal pension scheme. This will let you use Income Drawdown.
Category: Income Drawdown