What Is Pension Drawdown?
One of the most commonly used pension options is Pension Drawdown (FAD). It is also know as Flexi Access Pension Drawdown. It gives you the power to decide how much pension income you would like each year. However, add in the risk of running out of money, and this must be approached with caution. It can be seen as a huge benefit to have so much control and flexibility over your money in retirement, but for many, this will cause concerns over whether their pension can last until they die. If carried out correctly, Drawdown can be an appropriate form of income and retirement planning. As far as pension options at retirement go, this is the most popular.
Pension Income Drawdown allows you to take varying amounts of income as and when you choose. This replaced drawdown and capped drawdown plans after the pension freedoms rules on 6th April 2015. Drawdown is available with most providers, but not all, so it is worth checking with your existing provider if you are considering using this method. You may access your pension from the age of 55 and take up to 25% tax-free cash.
Pension Drawdown/Flexi Access Drawdown works as follows:
- Funds that have not yet been accessed are known as ‘uncrystallised funds’.
- Once you withdraw funds from your plan, this is known as ‘crystallising’ the funds.
- 25% tax free cash is taken for each amount crystallised, and the remaining 75% is allocated into Flexi Access Drawdown.
- At any time, you can take an income from your Flexi Access Drawdown account, and this is taxed as income. This can be accessed for regular income or ad-hoc withdrawals.
- To access a particular amount of tax-free cash, you must crystallise four times the desired amount. Therefore, you need to crystallise your entire pension pot and allocate the remaining 75% into FAD to receive your full tax-free cash.
- There is no annual limit to the amount of income you take from your FAD account, but remember that any withdrawal is taxed as income.
For example – you have a pension plan of £500,000 and decide to crystallise £20,000 of this to give an income. Since 25% is given as tax-free cash, you receive a lump sum of £5,000, and the remaining £15,000 is designated into FAD. You then decide to withdraw £1,250 per month as an income, and this is taxed as income.
After a year, you decide that £20,000 wasn’t enough income for you, so you decide to crystallise £25,000 and receive £6,250 as a tax-free lump sum, and £18,750 is designated into FAD. You then take an income of £1562.50 per month.
What Are The Advantages Of Drawdown?
Although it sounds obvious, the main advantage of income drawdown is the flexibility on offer. As the modern world becomes more complex, flexible retirement income is a priority for many. With FAD, you can change your regular income amount or take ad-hoc lump sums to suit your needs. Having these choices makes flexi access drawdown an attractive option as pension income in retirement.
Secondly, the ability to leave your money invested within the FAD plan means there is opportunity for growth. Whilst this might be risky in the short term, the benefits would be felt over a long period of time. This investment growth is vital to enhancing the possible income that you can take from your pension.
Your tax-free cash can be taken as and when you need it. If you would benefit from having your full 25% as a lump sum, that is perfectly fine. If you would rather enjoy 25% of your annual income tax-free, you can do that too. Depending on your requirements, there can be careful tax planning done around this area. Nobody likes to pay too much tax so this flexibility is a great asset.
If you pass away and have funds left in your Flexi-Access Drawdown plan, you can nominate who will receive these funds. Not only that, but they will receive the plan free of inheritance tax. Depending on the provider, they could continue to gradually take income to suit their needs. Click here to read our article on this for more information.
Can I Make Further Pension Contributions?
You may continue to contribute to your pension after commencing Flexi Access Drawdown. Still, once you have taken an income from your plan, your annual contribution for retirement planning will be restricted to £4,000 per year. This is known as the ‘Money Purchase Annual Allowance’. Any contributions over £4,000 per year will be subject to an annual allowance charge, effectively removing any tax relief gained when making your contribution.
What Are The Death Benefits Under Pension Income Drawdown?
Within your FAD plan, you have the option to nominate beneficiaries who will receive the benefits when you die. This is not limited to dependents, and more than one beneficiary can be chosen. Additionally, when your beneficiary dies, they can also pass the plan down to their successors.
Your FAD plan is outside your estate for inheritance tax purposes, but any tax-free cash or income you have taken out of the plan will be included as part of your estate.
Your chosen beneficiaries can either continue with taking income under the FAD plan, or they can withdraw all the funds as a lump sum and even use this to purchase an annuity if they wish.
If you die before the age of 75, the death benefits will be tax-free for your beneficiaries, but if you die at or after age 75, then they will be taxable. Click here for more information on tax on income drawdown.
What Is The Difference Between Flexi Access Drawdown And A Pension Annuity?
Your uncrystallised funds remain invested, and you have full control over the choice of investment. If you are relying on your pension for a considerable percentage of your earnings in retirement, it is recommended to ensure your chosen investments are not too risky.
This is because of an idea known as pound cost ravaging, which is when your funds fall in value on one hand due to negative investment returns, and on the other hand, due to income withdrawals. Following a large drop like this, the fund has to grow a much larger percentage to recover back to the same value.
Unlike pension annuities, your funds are not guaranteed to last until you die. Estimating how much income is sustainable can be a very difficult exercise due to variables such as investment returns, inflation, interest rates and your life expectancy. Mortality drag is the risk of you outliving your money and is a very real possibility for using FAD.
To help you avoid this, at Consilium Asset Management, we assess your situation in detail to ensure you do not spend above your means. Using extensive research and cashflow planning software, we can calculate a Sustainable Rate of Spending that you can afford, and this is reviewed each year to make sure your plan stays on track.
Drawdown is the term given to generally taking benefits from your pension pot. There are ways in which this can be done, and flexi drawdown is one of those ways. Alternatives include phased drawdown and Uncrystallised Funds Pension Lump Sum (UFPLS). The main difference between these is the timing that the tax-free cash is taken.
In brief, FAD involves taking a tax-free lump sum upfront. This could be 25% of your entire pot or 25% of a portion of your pot. The remainder then moves into FAD and then any income taken from FAD is taxable.
Under UFPLS, lump sums are taken from your pension pot and 25% of each of them are tax-free. This means that the full amount of your withdrawal hits your bank account rather than some being moved into FAD first, and 25% is tax-free cash.
For more information, on pension drawdown click here.
Capped Drawdown is no longer available to new applicants. This drawdown product ended in April 2015, but any pre-existing plans have been allowed to continue.
The idea behind capped drawdown is the same as flexi-access drawdown. However, clear from the name, the amount that can be taken as income from the drawdown part of your pot is limited. This cap is set at 150% of the rate set by the Government Actuary Department and is based on annuity rates of someone your age and in good health. The cap is reviewed every 3 years before age 75, and every year after age 75.
This was brought in to ensure that retirees did not take too much income during the early stages of retirement and then be left with no retirement savings in later life. After many years of running this scheme, it became apparent that retirees were being careful and many were seeking financial advice. This meant that in 2015 they announced flexi-access drawdown, which has no limits.
Can I Take 25% Of My Pension Tax Free Every Year?
Yes you can, if this suits your needs. You could either take your entire 25% tax-free lump sum in one go if, for example, you would like to pay off your mortgage. In this case, you would move 75% of your pension pot into Flexi-Access Drawdown, whilst the other 25% is paid to your bank account as tax-free cash.
Alternatively, you can save your tax-free cash and enjoy 25% of your retirement income each year free of tax. This might be beneficial for you if you have other income that would push you into a higher tax bracket. Having the choice of when and how to take your tax-free cash opens up many tax planning opportunities. The slow use of your tax-free cash is known as phased drawdown. You can read more about this here.
So, Is Flexible Drawdown A Good Idea?
The introduction of Flexi Access Drawdown has been a hugely positive change around retirement planning. It can give you the freedom to take control of your retirement. However, it does not come without its risks. Whether it is a good idea or not depends entirely on your situation. If you are already in drawdown or are considering FAD to provide your income in retirement, get in touch with us today. We can help and advise you on the best pension option for you.
