One of the most commonly used pension options is Flexi Access Drawdown (FAD). 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, FAD can be an appropriate form of income and retirement planning.
Flexible Access 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. FAD 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.
Flexible Access Drawdown works as follows:
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.
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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.
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.
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.
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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. 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.