Pension Drawdown

Pension Drawdown

There are a few ways you can access your defined contribution pension when you reach 55 (57 from 2028), and a pension drawdown is one option.

This article discusses the new generation of income drawdown arrangements (set up after 6th April 2015) which are also referred to as ‘income drawdown’, ‘flexi-access drawdown’ or ‘flexible retirement income’.

HOW DOES IT WORK?

A pension drawdown allows you to take some money from your pension pot, and the remainder stays invested. The idea is that the amount you keep invested will hopefully keep growing (if the investments perform well) for the many years you are in retirement.

There is no limit to how you can take your retirement income; you can take a regular income, take lump sum amounts whenever you choose, or take it all in one go (beware tax implications!).

Unlike an annuity where you can’t make changes once set up, with a pension drawdown you can make changes to the income you draw and can usually add other pension pots after it’s set up.

You can either set up a drawdown arrangement with your current pension provider, or transfer to a new provider who does allow pension drawdowns. It is important you check with your current provider what (if any) features/guarantees you may lose, and what charges you may have to pay. It is worth weighing this up against the value of moving and remember to shop around to see which provider would suit you best.

WHAT ARE THE TAX IMPLICATIONS?

You can usually withdraw up to 25% of your pension pot tax-free, with the rest incurring income tax.

So, keep this in mind if you want to withdraw all your funds in one go and have a large amount in your pension – you could be hit with a big tax bill!

You can also move your pension savings into a drawdown phase gradually, aka ‘phased drawdown’ or ‘partial drawdown’. This will allow you to take your 25% of each amount you move over as tax free cash.

If your pension pots are above the Lifetime Allowance (£1,073,100) when you access it (2021/22 tax year) you may be charged additional tax.

BEWARE PENSION RECYCLING LAWS

If you take the tax-free lump sum to pay into a pension pot to get tax relief, it may be considered Pension Recycling and you may be penalised. If HMRC deem you have broken the Pension Recycling laws – even if you have only recycled some of the amount you withdrew – you may be charged tax on the whole tax-free amount. It is wise to seek financial advice if you’re thinking about reinvesting some of your tax-free withdrawal back into a pension.

 

CAN I STILL ADD TO MY PENSION?

If you haven’t been adding to your pension, one rough rule of thumb is to take your current age, half it, then this is the percentage of your salary you should add to your pension until you retire. For example, if you are 35, 17.5% of your salary (35 / 2 = 17.5) should be going into your pension this year, next year, and every year until you retire.

This is a very rough rule, but it is a good way to emphasise just how much you should be putting away, and the longer you leave it the more you need to make up (thanks to compounding).

Again, this is a good guide, but it is a good idea to seek professional advice to see exactly how your salary and retirement expectations live up to this. You may need to put away more or less, depending on your circumstances.

 

WHAT HAPPENS AFTER I DIE?

The ‘death tax’ on pension funds was repealed on 6th April 2015. Now, your pension is treated differently depending on if you pass away before or after the age of 75.

IF YOU DIE BEFORE AGE 75 

Your pension will pass to your beneficiaries without incurring inheritance (or any other) tax.

IF YOU DIE AT AGE 75 OR OVER

Your beneficiary can have your pension paid to them as regular income, or they can take it as a lump sum. Either way they receive it, income tax will apply at their marginal tax rate. So, if they take the lump sum they may be charged a large amount in tax (if you have a large pension pot). [/vc_column_text][vc_column_text]Your beneficiary is no long required to be a dependent (like your spouse). It is important you complete your provider’s ‘Expression of Wish’ form so you can declare who you want to receive your pension when you pass.

WHAT TO BE CAREFUL OF

  • Pension drawdown arrangements can be expensive. It is important to shop around and get all the important information from each provider such as details on their fees and charges, the implications of leaving your current fund and weigh this up against the other ways you can take your pension income.
  • As the remainder stays invested (usually in the stock market), the value can go up or down depending on how the investments perform. You will have to choose where this remainder is invested, either from a selection of investments or some providers offer a choice from ready-made portfolios that match a potential retirement objective (called investment pathways). 
  • You decide how much to drawdown. This means you could run out of money if:
    • You drawdown too soon 
    • You live longer than expected
    • Your investments don’t perform as well as hoped

At the same time, if you are afraid you’ll run out of money and drawdown too little to be safe, you could be living a less enjoyable life than you could afford to. 

For all these reasons and more it is a good idea to seek professional advice. The Independent Financial Advisers at TCFP can help you choose the best way to receive your retirement income, how to invest your pension pots and how much you should be drawing down.

WHAT ARE MY OTHER OPTIONS? 

Thanks to the Pension Freedom legislation introduction in 2015, you have many ways you can choose to receive a pension income. Other than the pension drawdown, you can:

  1. Purchase an annuity
  2. Withdraw the whole lot 
  3. Mix of the above and Pension Drawdown options 

See our article about Pension Freedom here, which details all your options.

GETTING HELP

There is a lot to think about when deciding how you want to access your pension. Decisions you make now will affect your financial future, so it’s important to carefully consider what is best for you. 

The government have set up a free and impartial service to help you understand all your options called Pension Wise. Click here to get in touch with them. Note however, Pension Wise will give you facts and information only, they cannot give advice. 

If you want advice tailored to your personal circumstances you can get in touch here to chat to a TCFP financial adviser, and you can read our article about Financial Planning Specialists here to see what you can expect from us.

WHAT OUR CLIENTS SAY

“Jeremy explained the options that were open to me and my wife and transferred all the various different funds into one place where I could see at a glance how my pot was performing. He also provided models/illustrations/projections of how our finances might look in the future as we reached retirement and moved into old age” – Essex client (Testimonial from Vouchedfor).

You can find many more client testimonials here.

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