The Income Drawdown Option

There are choices about how you turn your pension fund into regular income for your retirement, and there are rules about how it can be done.

Choice number one is to take a tax-free lump sum and then use the remainder to buy a lifetime annuity from an insurance company, turning your pension fund into income you can use for the rest of your life.

If you do not want to buy a lifetime annuity right away, you can opt for an unsecured pension. This is for people who are under 75 years of age and gives you an income from your pension fund by using income drawdown or a short-term annuity. The remainder of your fund stays invested.

Here’s how income drawdown works: you can take up to 25 per cent of your pension fund as a tax-free lump sum. What you then draw as regular income from the remainder is subject to tax.

The most you can draw is 120 per cent of the amount you would usually get from a level single life lifetime annuity, and there is no minimum amount.

Your pension provider has to review the amount of income you drawdown every five years, and this amount must be less than the limit set by HM Revenue & Customs (HMRC). The limit you can drawdown is calculated using the standard tables prepared by the government’s Actuary’s Department and you can drawdown any income from your fund, provided it is below this limit.

Changes in the limit may mean that you can drawdown a smaller or larger income, depending on what the new limit might be.

There are risks attached to drawdown:

• Your fund could fall in value, which means you would receive a lower income in future
  
   

• There may be set-up and annual charges on the investments in your fund, and;

• If you add together these charges and your income, and the result is more than any growth in your fund, the value of the fund will go down.

Your pension provider may have to review your fund every five years, but this is a long time. As a consequence, we believe your financial advisor should also review your plan on an annual basis to ensure that your fund is growing at a rate that makes up for the income you take from it.

You may, at any time, stop the arrangement and use what is left of your fund to buy a short-term or lifetime annuity.

Income drawdown is a flexible option, because you may still make changes to your plan. These include:

• Varying the amount of income you drawdown;

• Changing the funds your pension is invested in, and;

• Stopping the plan at any time and buying an annuity with the remainder of the fund.

You may transfer your plan, but not all providers accept this and you might be charged for the transfer – we believe it is prudent to check your provider’s terms and conditions.

When you reach 75 you have to convert your pension fund into income, which generally means buying a lifetime annuity although there are other alternatives if you continue with the drawdown option it then becomes known as “alternatively secured pension”..

If you die before 75 without having bought an annuity, you may leave your pension fund to your partner and any dependants. They then have a choice to make, and some choices face larger tax bills than others. The options are:

• Taking some or all of the remaining fund as a lump sum, which is currently taxable at 35 per cent;

• Continuing to withdraw income as before, or;

• Buying a lifetime annuity or one of the other options, such as an alternatively secured pension, with the whole fund.

Some occupational money purchase schemes allow drawdown, while others do not. If your scheme does not allow you to drawdown, you may transfer your pension rights to a personal pension scheme – your financial advisor will usually charge for this.

Obviously, this can be a very complex process which can cost money if inappropriate decisions are made. It is there fore vital in most circumstances that professional advice is taken.