Income Drawdown. An alternative route into retirement - this guide explains the risks and benefits of income drawdown

Transcription

1 INCLUDING FLEXIBLE DRAWDOWN Phone: Visit: Income Drawdown An alternative route into retirement - this guide explains the risks and benefits of income drawdown What s inside: How income drawdown works The advantages and disadvantages Why it is more flexible What could go wrong Investment strategies you might consider WINNER Corporate Platform/Wrap Provider of the Year Hargreaves Lansdown

2 AN INTRODUCTION Income drawdown - an introduction Income drawdown is the main alternative to an annuity. It is one of the most flexible retirement options available but this does make it more complex.this guide explains the risks and benefits. It aims to give you information to help you make your own financial decisions but it is not personal advice. Income drawdown puts you in control of your retirement pension. Instead of exchanging your pension fund for a secure income for life (an annuity), drawdown allows you to draw an income directly from your pension, whilst keeping the rest invested. It offers the potential for growth and a chance to protect your income from inflation, as well as an opportunity to pass your pension fund on when you die. At first glance, income drawdown might appear a saviour to investors worried about the inflexibility and limited death benefits provided by an annuity, especially at a time when annuity rates are at record lows. However, with the benefits of drawdown come big risks. There is more that can go wrong. How does drawdown fit in? Drawdown can be used in conjunction with other retirement options, or on its own. The other main options for private pensions are: Lifetime annuity - a regular income for life in exchange for your pension Phased retirement - rather than convert all your pension in one go, you can split the pension and take benefits in phases. In this guide, where we mention annuities we are referring to a secure conventional annuity. It is possible to buy an investment-linked or variable annuity where your income could fluctuate, or a fixed-term annuity, however these depend on the performance of an underlying investment fund and income can fall as well as rise. For more details on the other options, please see our Options at Retirement guide or visit In this guide, where we have made references to spouse s pensions in an annuity, this generally includes civil partners and financial dependants. None of this drawdown guide may be reproduced without permission. Issued by Hargreaves Lansdown Asset Management Ltd, 1 College Square South, Bristol, BS1 5HL. CONTENTS 3-4 What is income drawdown and how does it work? 5 Flexible drawdown 6 What happens when you die 8 Pros and cons 9 What could go wrong 10 Case study Investment Strategies 13 Could drawdown be for you? 15 Important Investment Notes & Technical Notes 2

3 YOUR DRAWDOWN OPTIONS What is income drawdown? Income drawdown allows you to draw a retirement income directly from your pension fund, whilst keeping the rest invested. You stay in control of your pension and make all the investment decisions. It may be possible to increase your income if your investments perform well. However, if investments don t go the way you want, and if the pension pot is depleted by excessive income withdrawals or poor investment performance, your income will be reduced - the responsibility rests with you. You can use your income drawdown fund at any time to buy an annuity. However you don t have to buy one at all if you don t want to. If you die whilst in income drawdown, there is more flexibility. The remaining fund can either provide an income for your dependants or it can be passed on to anyone you choose less a 55% tax charge (see page 6 for more details). The bigger picture At one end of the scale is the dependable secure income for life that comes with an annuity; at the other is the much more flexible, but riskier, income drawdown. You can also mix and match the two. Both options have their own advantages and disadvantages. It is important you fully understand both options before deciding which works best for you. To put it in simple terms, it is rather like choosing between a Volvo and a Ferrari. Both have strengths and weaknesses. It depends on what you want: something sturdy and secure for a long journey, or a thoroughbred that needs care and attention for a less uncertain but perhaps more rewarding and exciting ride. An annuity is the most common option at retirement. It is also very simple: you exchange your pension fund for a secure income for life provided by an insurance company. Your income will continue to be paid regardless of investment performance or how long you live. There are downsides of course. We ve covered the pros and cons later in this guide (see page 8). The annuity benchmark As with any important decision, make sure you have the full picture. Whatever your plans, it could be wise to find out the best annuity you could obtain (including any enhancements for health conditions). This will be a useful benchmark when considering drawdown. UP TO 25% TAX FREE CASH FUNDS REMAINING ARE IN THE DRAWDOWN ACCOUNT INCOME Tax-free cash and a taxable income When you re ready to start drawing your pension, you can normally take up to 25% as taxfree cash and use the remainder to provide a taxable income (using an annuity or income drawdown). INCOME INCOME Most people decide to take the lump sum because, unlike any income you take from the pension, it is tax-free. If you do not choose to take tax-free cash at the start it is not possible to take it at a later date. In income drawdown you take taxable income directly from the fund, within limits. Unlike an annuity income it is not secure and could rise or fall in future. Hargreaves Lansdown - Income Drawdown 3

4 DRAWDOWN EXPLAINED Take variable income directly from the pension fund each year and choose where to invest. Income limits are reviewed at least every three years. How does drawdown work? Firstly, you decide how much of your pension you want to move into drawdown. You can normally take up to 25% of the amount you are converting to drawdown as a tax-free lump sum and you can draw an income from the rest. Any income is subject to tax at source on a Pay As You Earn (PAYE) basis. You decide where the drawdown fund is invested, and you should review the situation regularly (top tip: you may find online access invaluable, enabling you to monitor investments whenever you like). The amount of income you can draw depends on whether you choose income drawdown or flexible drawdown. choose when you take it. Each Pension Year you can take up to your maximum income but if you do not take the full amount it cannot be carried over to the next year. Your Pension Year starts on the day you enter income drawdown and runs for 12 months from that date. It does not run in line with the tax year. An annuity income could be higher than the maximum income allowed under income drawdown because the GAD calculation does not take health, lifestyle or other individual factors into account. Previously income drawdown had to end at age 75, but it is now possible to remain in income drawdown indefinitely. INCOME DRAWDOWN Choose an income between zero and your GAD maximum There is no minimum withdrawal amount for income drawdown so you could choose zero income if you wish and simply take tax-free cash. The maximum income is intended to be roughly equivalent to the income from a level, single life annuity bought using the same value of pension fund. It is calculated using tables from the Government Actuary s Department (hence it is called a GAD review). The GAD tables use your age and 15 year gilt yields to calculate the income available from your fund. The income limits are fixed until the next review. You can alter the income you take (within the limits) as you go along, and Reviews for income limits before age 75 Before age 75 your limits must be reviewed at least every three years. At each review the new maximum income could be lower or higher than the limit from the previous three years. A review (resulting in a new maximum income) could be triggered before your three year review if you switch any more money into your drawdown account or if you use some of the drawdown fund to buy an annuity. In some cases funds may also have to be moved out as a result of a divorce court order which could trigger a review. Every year, you also have the option to manually request that a review takes place on the plan anniversary. This will reset income limits and restart the three year period. Reviews for income limits after age 75 Your drawdown plan will need to be reviewed on each plan anniversary and you will have a new maximum income limit every year. 4

5 FLEXIBLE DRAWDOWN FLEXIBLE DRAWDOWN Choose unlimited income Flexible drawdown - if you qualify - has no income limits at all. You can take tax-free cash and draw as much income as you need, when you need it. However it is not available to everyone. There are certain criteria that must be met before you can choose flexible drawdown. Main requirement: Secure pension income of 20,000 To qualify for flexible drawdown you must already be in receipt of a secure pension that will pay an income of at least 20,000 in the tax year in which you move into flexible drawdown. When you apply we will ask you for details of this income. There are strict rules on what income can be included. Below we have outlined the basics however if you re not sure contact us for details. For investors who don t quite have the 20,000 of pension income needed, an annuity can be purchased using part of your pension to meet the shortfall, allowing the rest of your fund to be used for flexible drawdown. Please call us if you d like us to help. Other requirements Flexible drawdown can only be taken once you have finished saving into pensions and have ceased being an active member of all your pension schemes. In particular, no pension contributions can be paid to a money purchase pension (e.g. personal pension, stakeholder, SIPP or AVC) in the tax year you make a flexible drawdown declaration. When you apply for flexible drawdown it is not possible to be an active member of a pension scheme containing defined benefits (e.g. final salary, career average schemes, GMP, some company provided life cover). If a contribution is made in the tax year in which you apply for flexible drawdown your plan will lose its flexible status and you will revert back to standard income drawdown and be subject to the maximum income limits. Any income payment already made in that tax year which exceeds the maximum income limit will be treated as an unauthorised payment subject to a tax charge of up to 70%. The flexible drawdown declaration should be signed in the same tax year in which you want your plan to enter flexible drawdown. Taxation of income Any income payment from flexible drawdown is taxed as income in the tax year in which it is received. There are tax advantages to keeping the money within a pension. Funds are sheltered from UK capital gains tax, there is no further UK income tax on investment income and the pension fund can normally be paid out free of inheritance tax on death. The value of tax shelters will depend on your personal circumstances and can be changed by the government. Using flexible drawdown to provide a retirement income in place of income drawdown requires a greater awareness of the effect that drawing an income has on your fund. It is important to consider how long you will need this fund to last. 20,000 PER YEAR IN SECURE PENSION INCOME WHAT COUNTS? 3 7 Secure private pension income (eg an annuity or scheme pension) Some variable annuity income Secure occupational pension income (if this is final salary pension there must be at least 20 members receiving an income) Income drawdown income or income from a dependant s drawdown plan Income from a deceased spouse or partner s pension if it is already in payment to the dependant Income from investments State pension income and other social security benefits: Basic state pension, SERPS and S2P Graduated Retirement Benefit Industrial Death Benefit, Widowed mother s allowance, Widowed parent s allowance, Widow s pension Other sources: Payments from some overseas pensions Payments under the Financial Assistance Scheme Regular payments from the Pension Protection Fund Income from property Income from Purchased Life Annuities (PLAs) Hargreaves Lansdown - Income Drawdown 5

6 DEATH BENEFITS What happens if you die before taking benefits? Until recently, individuals have had to set up an income from their pension by age 75, but it is now possible to leave your pension fund untouched indefinitely, although treatment differs from age 75, as the following tables show. Taking benefits means taking an income or tax-free cash, or both. IF YOU DIE BEFORE AGE 75 Any money remaining in your pension which has not been used to provide retirement benefits (i.e. tax-free cash, income drawdown or an annuity), can usually be passed as a lump sum to a nominated beneficiary free of any tax charge. It is also possible for a spouse or dependant to use the funds to provide a taxable income. IF YOU DIE AFTER AGE 75 It is now possible to leave your pension untouched for as long as you like. However at age 75 the death benefits on your pension fund change and any remaining money becomes subject to income drawdown death benefit rules (see below). Hence lump sum payments become subject to a 55% tax charge. What happens if you die after taking pension benefits? This is one of the areas in which annuities and drawdown significantly differ. This table shows the main differences, based on our current understanding of tax and pensions rules which can change and will depend on your individual circumstances. If you are worried about tax charges on death, you should seek advice. What if I just take tax-free cash? Even if you have just taken tax-free cash but have not yet drawn any income, the fund is normally still considered to be in income drawdown and will be subject to the death benefits outlined. In particular if you die whilst in income drawdown any lump sum payments are normally subject to a 55% tax charge. Do you have to decide death benefits at outset? What if no death benefits chosen at the start? Options for continuing taxable income ANNUITY Yes. You have to decide these when the annuity is set up. They will affect the level of income you receive. You cannot normally change them. No further payments. The annuity will end on your death. If you ve selected a spouse s pension. Payments will continue to be made to your spouse until their death. However it could be wasted if your spouse dies before you or if you divorce; or If you ve selected a guarantee period of up to ten years. Your annuity will be paid out for the remainder of that period if you die before then. If you survive the guarantee period, the income will be paid for the rest of your lifetime only and then stop, unless you ve chosen a spouse s pension. INCOME DRAWDOWN No. No advance decisions required. You can nominate to whom you d like death benefits paid but this can be changed. The options below can apply. Your dependant(s) carry on with income drawdown. The drawdown fund is passed to them without any tax charge, then any income taken is taxable at their personal income tax rate. Your dependant(s) use the remaining pension to take flexible drawdown provided they meet the set criteria, (including being in receipt of at least 20,000 secure pension income). Any money taken out as flexible drawdown is taxable at their personal income tax rate. Your dependant(s) take the fund and buy a lifetime annuity. The drawdown fund will not be subject to a tax charge but income from the annuity will be taxable at their personal income tax rate. Any return of pension fund? No unless you have chosen a money back option (value protection) where an amount up to the original purchase price, less any gross income payments received, can be returned less 55% tax if you die before a set age. Yes. Any person you nominate could receive the remaining fund as a lump sum less a 55% tax charge. OR A lump sum could be paid to your nominated charity. If you have dependants this payment will usually be subject to a 55% tax charge. If there are no dependants the payment is made free of tax. 6

7 FACTORS TO CONSIDER Weighing up the options Annuities are dependable but inflexible Annuity options need to be chosen at the start. Once set up, you cannot normally change the annuity. This can be an advantage as the insurance company can t reduce the income they ve promised you. Regardless of what happens, they shoulder the risk. Buying an annuity is a one-off decision and unless you have chosen additional death benefits (see page 6) the annuity will cease when you die. An annuity does not allow you to take future circumstances into account. Current annuity rates (and gilt yields) are low Annuity rates have fallen over the last decade despite short term fluctuations. A major factor affecting annuity rates are gilt yields, which are at a 300 year low at the time of writing. These also mean the GAD rates used to calculate drawdown income limits are low. The following graph shows the trend of gilt and bond yields compared with annuity rates since HARGREAVES Source for Gilts LANSDOWN and Corporate ANNUITY Bonds: Markit INDEX IBoxx Benchmark Indices 15 Gilt and Bond Yields (%) Sept 05 Gilt Yields Corporate Bond Yields Annuity rates Sept 06 Sept 07 Sept 08 Sept 09 Source for Gilts and Bonds - Markit Iboxx Benchmark Indices 15yrs +. Source for Annuity rates: Hargreaves Lansdown, showing top rate on our panel for male aged 65 who is in good health and a non smoker, with a pension fund of 100,000 and no tax-free cash. The annuity is single life, level with a five year guarantee, paid monthly advance. If gilt yields rise (and you may take the view they can t fall much further) this could boost annuity rates, although there are no guarantees. As well as gilt yields, life expectancy has a part to play. As people are living longer, annuities have to be paid for longer, and rates have been gradually going down. The lower the annuity rate, the lower your income. The introduction of unisex annuity rates from December 2012 could decrease male annuity rates further and marginally increase female rates, although the exact impact of this change is unknown. Proposed future changes to the cash reserves annuity companies are required to hold (known as Solvency 2) could also push down annuity rates. Sept 10 Sept Annuity rate (%) How long will you live? Will you run out of income? With annuities, there is a misconception that when you die the insurance company pockets all your hard earned money. In fact, the people who die earlier than expected subsidise those who live longer. The key point is that you will never run out of money. Income drawdown relies on you being able to make sustainable withdrawals for the rest of your retirement. You may live longer than expected or your income could dwindle. It is therefore only a consideration if you are in a position to cope with these risks. On-going costs When you buy an annuity any set up costs and on-going charges are included in the rate you receive. You will not be charged anything further and will simply receive your income when it is due. Income drawdown is different. The extra flexibility has a cost. Charges for on-going administration and investment management will be deducted from your drawdown account (a reason why low charges are important) and you will need extra fund growth to make up for them. Charges could effectively rule out drawdown as an option if your pension fund is relatively small. Don t forget to take the cost of any financial advice into account. The danger of inflation A level annuity is a popular option but it could halve its value in real terms in 30 years or less thanks to even modest inflation. It s worth considering how inflation could affect your income. It s possible to buy annuities that increase each year (the starting income will be lower) or you might consider a mix and match approach, using a combination of annuity for secure income and drawdown for inflation proofing potential. In income drawdown you have the chance to increase your income later in retirement if you make the right investment decisions, but if you take too much income or your investments perform badly you may have trouble later, particularly if you don t have other sources of income. Mix and match It is usually possible to combine income drawdown and an annuity. One part of your pension can be used to buy an annuity, providing you with a secure income to cover your essential living costs. The remainder, which you might potentially afford to take more risk with, could then be placed into drawdown to provide a flexible additional income to supplement the annuity. Phased retirement - taking your benefits in stages You do not have to move all your pensions into an annuity or income drawdown at once. It is possible to phase the process, which can be tax efficient. Tax-free cash and income is taken from the part you move into drawdown, the remainder is left untouched in your pension. Both standard income drawdown and flexible drawdown can be used in this way. As your income from employment decreases you can either increase the income you draw from your income drawdown plan, move new parts of your pension into drawdown or use some of your pension to buy an annuity. Leaving some of your pension untouched can have tax benefits too. Hargreaves Lansdown - Income Drawdown 7

8 THE PROS AND CONS The advantages and disadvantages The option you choose will depend on which features and benefits are important to you, what risk you can afford to take, and how much flexibility you require. Here is a summary of the main pros and cons. CONVENTIONAL ANNUITIES ADVANTAGES Simple, easy to understand. No on-going reviews required Once set up income is fixed and secure Available for any size pension fund, with a number of different features. Higher incomes available if you have health issues The income will never run out, however long you live Not affected by stock market falls, or economic slumps DISADVANTAGES Inflexible, cannot be changed once set up Current annuity rates are low Benefits must be set up at outset so don t take account of changing circumstances. For instance a spouse s pension could be wasted on divorce or the death of a spouse An annuity (without value protection) cannot generally be passed on to your beneficiaries as a lump sum Not affected by stock market rises A non-inflation linked annuity has no protection against inflation meaning income in real terms will reduce over time. REASONS TO CONSIDER DRAWDOWN You keep your options open. Unlike an annuity, drawdown does not require any one-off decisions. This may appeal if you d like to cater for changing personal circumstances over a retirement lasting 20 years or more. There s a downside of course: income is not guaranteed (see next page for what could go wrong). You stay in control. You choose where you pension is invested, and how much income you take. Your income will depend on how well your investments perform. You decide how much income you draw and when you draw it. Income can range from zero up to a set maximum. This income can be paid monthly, quarterly, half-yearly or annually or as one off payments when you need them. If you qualify for flexible drawdown you could even take out the full fund. If you decide drawdown is no longer for you then you can buy an annuity at any time. Potential to protect your income against inflation. If your investments go the way you want (again see what could go wrong) then income drawdown offers the chance to receive an increasing income in retirement which could help protect against inflation. Pass on your pension when you die. With an annuity you have to decide up front whether you want to build in death benefits which affect the annuity income (and might be lost if your spouse dies first, or you divorce). With income drawdown you don t pre-select death benefits and your beneficiaries have the option of taking the remaining pension as a taxable income or a lump sum (less 55% tax charge). See page 6 for details. INCOME DRAWDOWN ADVANTAGES More flexible; you keep your options open and do not have to make any one-off decisions You retain investment choice and control On death, any remaining pension can be passed on to beneficiaries (less 55% tax) You can change the income you receive to match your requirements Potential for growth, increasing income and protection from inflation DISADVANTAGES Income is not secure. The income and value of the fund can fall and, at worst, the income could run out You re responsible for maintaining sustainable income. High income withdrawals and/or poor investment performance can strip the fund bare An annuity set up on day one may have offered a greater total income over lifetime More complex, you may need advice. Requires regular reviews Can be expensive: may not be cost effective for smaller funds. 8

9 WHAT COULD GO WRONG What could go wrong? You must understand the biggest risk of income drawdown. Your fund could be significantly (if not completely) eroded in adverse market conditions, or if you make poor investment decisions. This in turn will lead to a lower (perhaps no) income later in retirement. Making the wrong investment decision in income drawdown could cost you thousands in lost income, at worst leaving you destitute in your twilight years. If your pension will be your main source of retirement income, you need to take far more care in your decision to go into income drawdown and seriously consider whether a secure annuity would be more appropriate. If you are in any doubt whatsoever we believe you should seek professional financial advice. Investment common sense As well as the investment risk your fund will have to work hard to keep up with income withdrawals, charges and inflation. This means anyone considering income drawdown needs a significantly more adventurous attitude to investment risk than someone buying an annuity. Lower-risk investments may struggle to keep pace with the income you withdraw, while higher risk investments could mean the capital will be subject to large fluctuations. Taking income may erode the capital value of the fund, especially if investment returns are poor and a high level of income is taken. We cannot emphasise enough that the worst case scenario is where the value of your pension fund falls dramatically, leaving little or nothing to provide income or an annuity for you or your spouse. This is more likely to happen with a high risk investment strategy. As an extreme example, your fund could be entirely invested in the shares of a single company, which then goes into liquidation, losing you everything. Investing solely in cash isn t risk free either, particularly when interest rates are low or inflation is high. Inflation will erode the real value of cash and you risk depleting the fund if you take income at a faster rate than the fund can grow. The maximum income that can be taken in income drawdown may not be sustainable. Take a careful look at our case study on page 10. Once you have lost money in retirement it is extremely difficult, if not impossible, to get it back again as your sources of income are limited and returning to the workplace is unlikely. If you live longer than expected, there is always a risk that you may run out of money. There is the risk that annuity rates may have fallen if you choose to buy an annuity in the future. GAD rates may fall in future, meaning the maximum income you could take is reduced. Combined with a smaller pension fund due to poor investment returns this could dramatically reduce your income (note at the time of writing GAD rates are at the lowest they can currently go). There are things you can do to manage these risks. By adopting a sensible investment strategy and ensuring withdrawals are sustainable these risks are significantly reduced (see later on in this guide for more on investment strategies). Hargreaves Lansdown - Income Drawdown 9

10 CASE STUDY Income drawdown case study The following example is fictitious, but all too possible. It is designed to highlight the dangers of drawdown. A man goes into income drawdown on his 65th birthday with a 250,000 pension fund and starts taking the maximum income he is allowed, annually in arrears. In the first three years the market falls sharply by over 50% before making a modest recovery for the next three years. The withdrawals prove a massive drain on his fund and at the first three yearly review his maximum income falls 53% from 13,250 to only 6,210 for the next three years. By the end of year three his fund falls 57% to only 107,071 and would have to more than double to regain his original capital, even if he takes no further income. By the end of year four his capital has risen slightly, but by now the damage has been done. If he had bought the best annuity rate at outset he would have had a secure 15,145 a year for life, with no worry and no on-going reviews. By the end of year seven the income from the annuity would have totalled 106,015. Notes The maximum drawdown income is correct as at August 2012 for a male age 65 in year one of the policy and the annuity income quoted is the best rate available on the open market for a 65 year old non-smoking male, level, no death benefits and paid annually in arrears (current rates as at August 2012). Annuity options can be adjusted to meet your requirements: please contact us for an up-to-date quote. Cash by itself is unlikely to be a suitable long term investment for drawdown. In particular when cash interest rates are low, investing in cash alone will not generate enough income to match the income you could get from an annuity. To achieve this level of income you will almost certainly need to consider other investments which contain a higher degree of risk and can fall or rise in value. As the case study highlights a combination of excessive withdrawals, inappropriate investment selection and falling markets could massively deplete a fund that has to sustain you for the rest of your retirement. If you choose income drawdown you need to be willing to manage the risks. Two ways of doing this are taking less than the maximum income permitted and investing in a diversified mix of investments (see strategies on pages 11 and 12). OUR CASE STUDY IS BASED ON THIS MARKET SCENARIO FTSE 100 INDEX Jan 2000 Jan 2001 Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan 2007 FTSE 100 The case study is fictitious but closely follows the performance of the FTSE 100 Index from January 2000 to January 2007 (above, source Lipper). IF YOU MOVE INTO DRAWDOWN AN EXAMPLE Position now for male age 65 year one year two year three year four year five year six year seven Value of fund 250, , , , , , , ,894 Investment return -11% -17% -25% 14% 8% 17% 11% Maximum income limit - reviewed after three years* Total income taken under income drawdown (annually in arrears) 13,250 13,250 13,250 6,210 6,210 6,210 8,639 13,250 26,500 39,750 45,960 52,170 58,380 67,019 IF YOU BUY AN ANNUITY AN EXAMPLE Position now for male age 65 year one year two year three year four year five year six Value of fund 250,000 N/A N/A N/A N/A N/A N/A N/A year seven Level of income each year 15,145 15,145 15,145 15,145 15,145 15,145 15,145 Total income taken if annuity purchased (annually in arrears) 15,145 30,290 45,435 60,580 75,725 90, ,015 *Taking the maximum income permitted by HM Revenue and Customs may not be sustainable 10

11 INVESTMENT STRATEGIES Income drawdown investment strategies A sensible investment approach could mean the difference between success and failure. Below we have highlighted a few common scenarios in drawdown and a possible investment strategy for each. Note these strategies are not advice. The aim is to get you thinking about your own investment approach. Other factors including your goals, your other sources of income and your attitude to investment risk will help you choose where to invest. The importance of diversification All investments carry risk. Even cash can cause the real value of your pension to fall over time if the interest rate is less than the rate of inflation. While investment risk can t be eliminated altogether, you can reduce its effect with a diversified spread of investments. The impact of picking the wrong asset type, the wrong region, or the wrong sector is significantly reduced if a portfolio covers a range of assets, regions and sectors. Getting a balance of investments may be considered boring and pedestrian by some, but it could potentially reduce the risk of making a wrong move. Some investments, such as certain unit trusts and OEICs, spread risk across several asset classes, sectors and geographical areas and within those, across dozens of different investments. It is also important to try and get a spread across different providers in case a particular fund manager s performance goes off the boil. A spread of different funds can also provide access to different fund managers investment styles, which can outperform at different stages of the economic cycle. Consider a well diversified portfolio of asset classes such as: Cash - to pay out income (especially in the early years) and for a cash buffer. Fixed interest (corporate and government bonds) - to generate income and provide diversification from other higher risk investments. Equities - potential for higher long term returns through capital growth and dividend income. For more investment ideas you can consult our Wealth 150, a list of our favourite funds in each of the major sectors. Or take a look at our website It explains more about the investment strategies you could adopt and highlights a few funds for each of these strategies. Whichever strategy you choose it s a good rule of thumb to hold at least a year s income requirement in cash to avoid having to sell investments when the market is down. Income drawdown investment strategies continued on page 12 Hargreaves Lansdown - Income Drawdown 11

12 INVESTMENT STRATEGIES SCENARIO 1: TAKING A REGULAR INCOME Here the key point is if the performance of your investments fails to match your withdrawals the value of your fund will be depleted and your future income will fall. Investing purely in cash is also unlikely to be a suitable strategy as this will not produce the level of returns required to sustain withdrawals. There is a balance to get right: if you take too much risk and the market falls significantly your income (and future income) will reduce, especially if you take withdrawals after the market has fallen. So what can you do? There are investment strategies you can adopt to manage these risks. Natural yield drawing the income generated by the underlying investments. One approach is to draw the income generated by your investments, typically via dividends or income from bonds. This approach is called drawing the natural yield. This allows you to take an income from your pension whilst leaving the underlying capital intact. Should markets fall, you should still receive an income whilst you wait for the capital to recover. In tough times the income could also fall. Income-focused investors could consider bonds and high dividendpaying shares, accessed via a portfolio of Corporate Bond and Equity Income funds. Despite recession and hard economic times, some businesses will be in good shape; perfectly capable of servicing debts and maintaining dividend payments. Corporate bonds should dampen a portfolio s volatility, while equity income funds can offer potential for a rising income and capital growth over the long term. Please remember however that the income will vary and both the income and the capital could fall. Capital drawdown considering total return, not just income. For some investors the natural yield doesn t provide enough income so some capital withdrawals are necessary. There are inherent risks your fund growth will have to keep pace with your withdrawals or the value of your pension will fall, reducing the level of income you can take. You might want to consider investing some of your portfolio in absolute return funds which aim for positive returns regardless of what happens in the general market, although returns are not guaranteed and they can and do fall at times. SCENARIO 2: TAKING OCCASIONAL WITHDRAWALS SCENARIO 3: NOT TAKING AN INCOME You may decide to take the available tax-free cash and leave the rest of your pension invested. There is no requirement to take an income if you don t need or want one. In this case your investment strategy will depend on when and how you plan to start drawing an income. If you are planning to buy an annuity at some point in the future it could be wise to start gradually reducing investment risk as you get nearer to your intended purchase date. If, when you come to buy your annuity, your portfolio is in cash and fixed interest securities, this might prevent a sudden fall in the equity market depleting your fund. However if you don t intend to take an income at all until much later in retirement you can probably afford to be more aggressive in your investment approach. Your retirement could last years, over which time shares have historically out-performed other asset classes, although past performance is not an indication of future returns. Rather than invest in shares directly which can be very volatile, you may wish to gain exposure through collective investment funds (such as a unit trust or OEIC). Here the investment manager spreads your money across a range of shares or other funds spreading the risk. It may be worth choosing funds which invest across different geographies and sectors, again to diversify. SCENARIO 4: HIGH WITHDRAWALS FROM FLEXIBLE DRAWDOWN PLAN Some investors may wish to take high withdrawals from a flexible drawdown plan because they are not dependent on it. In this case the right investment approach will depend on the size of withdrawals you are looking to take and the time period over which they will be taken, as well as the alternative sources of income available. It s also likely to be a highly individual decision, to fund a wedding or house purchase for instance. If you are looking to withdraw your entire fund over a period of less than 5 years and can t afford for the fund to fall too far you might stick to cash, perhaps with some exposure to fixed interest, and absolute return funds. The aim would be to prevent market falls significantly reducing the size of your pension pot before you have taken the necessary income. If you re looking to take ad-hoc withdrawals from your drawdown fund to cover unexpected expenses you should maintain a significant emergency cash buffer. If you invest solely in higher risk investments which can be more volatile, you risk having to sell your investments at precisely the wrong time, e.g. following a fall in the market. This would erode your pension pot. You could consider investing part of your portfolio in corporate bond and equity income funds. Rather than re-investing the income you could leave it to accumulate on your drawdown account to build up a cash buffer. This accumulated income could then be used to fund ad-hoc withdrawals, avoiding the need to take capital withdrawals. 12

13 IS DRAWDOWN FOR YOU? Could income drawdown be for you? ANY QUESTIONS? CALL US ON (Mon-Thurs 8am-7pm Fri 8am-6pm Sat 9.30am-12.30pm) Income drawdown may be a consideration if: You are happy to make your own investment decisions and are comfortable with stock market investments You have other sources of income in retirement so can accept some income fluctuations You would like an income that has the potential to increase and maintain its value in line with inflation, although this is by no means guaranteed You are happy to accept the on-going costs, regular review and administration that drawdown entails You would like to maintain control and flexibility over your pension pot You are willing to accept that your income could significantly fall as well as rise. 24 hour access to your investments via the HL - Vantage Drawdown account - available online, by phone or smartphone and by post. See overleaf for reasons to choose Hargreaves Lansdown for drawdown. Hargreaves Lansdown - Income Drawdown 13

14 THE VANTAGE SIPP Which drawdown account will you choose? If you ve decided income drawdown might be for you, the next question is: which provider? Like most things, drawdown has evolved and got better over the years. But charges, services and features vary drastically between providers so it s important to choose the plan that s right for you. Hargreaves Lansdown offers drawdown in the HL Vantage SIPP (Self Invested Personal Pension). Below we have highlighted three reasons to choose income drawdown through Hargreaves Lansdown: Low charges. The Vantage SIPP is one of the lowest cost plans on the market. There s no set up charge, no transfer fee, or inactivity charge. There is no charge for having regular income payments. For a full fee schedule see the Important Information and Key Features for Income Drawdown from the Vantage SIPP. The lower the charges the more money there is left for your retirement. Easy to set up and manage. Opening a drawdown account is easy. We will arrange everything for you. You can even transfer in existing drawdown pensions as well as most pensions you ve been building up. You ll have online access as well as telephone and postal support if you prefer. Most investments can be viewed, bought and sold online at the click of a mouse. You can call our helpdesk and speak to a real person. There is no call centre or automated options to navigate; just friendly, knowledgeable and well trained staff who will be delighted to help you. Wide investment choice. The Vantage SIPP offers a wide investment choice including thousands of funds, shares, bonds, and cash. You have access to the UK s top investment managers. If you ve taken a look at our investment ideas on page 11 and 12 and want to find out more, we offer a huge range of investments that fit within these strategies. Our drawdown plan is offered to you without advice as standard to suit those happy to make their own investment decisions and take responsibility for their pension themselves. That s not to say we don t offer access to financial advice, but you just pay for the advice you want. Income drawdown is a complex product and if you are at all uncertain about its suitability for your circumstances we strongly suggest you do seek advice. Please call us on and we will put you in contact with an adviser. I DON T INTEND TO GIVE UP WORK COMPLETELY SO I WANT THE FLEXIBILITY THAT INCOME DRAWDOWN GIVES Mr. Hones from Chester uses drawdown to reduce his working hours as he approaches retirement I chose the Vantage SIPP because I wanted to put all my pensions in one place and self manage my funds. This would give me the opportunity to improve on the near zero performance that some of my with profit funds with other providers had returned. I then took income drawdown to get access to my tax-free lump sum, which I used to buy a new motorbike among other things. It has allowed me to finish work at age 55 and I can now reconsider my options. I don t intend to give up work completely so I want the flexibility that income drawdown gives. I will either not draw an income or draw it alongside income from part time work. In my circumstances and at my age I am very pleased at how flexible pensions have become. The transfer process was very quick and efficient from your side, however I was appalled with the lack of transparency with my old pensions and with the error which one provider made. I just wonder how many people are affected by the inefficiencies of these companies. However you were fantastic and your charges for moving into drawdown were minimal. With the SIPP being online I now have everything at my finger tips. I can monitor the value of the pension funds and I tend to check it on a weekly basis. I had online access with one of my previous providers but it was very limited. Income drawdown in the Vantage SIPP has helped me to semi retire and re-evaluate my career options. NEXT STEPS Not had an illustration yet? A personal illustration shows you exactly how much income you could take if you started income drawdown now. It also helps you review how charges and investment growth can affect your income and fund value over time. The pack also contains everything you need to apply should you decide to proceed. Request your free illustration today at or call us on Already got your illustration? After reading your illustration, the key features and terms and conditions of Drawdown in the HL Vantage SIPP, simply complete the application form, return it to us and we will do the rest for you. If you need any help with the form please don t hesitate to call us on and we will be happy to help. 14

15 IMPORTANT NOTES Important Investment Notes & Technical Notes Important Investment Notes All investments should normally be held for the long term as their value can fall as well as rise, therefore you could get back less than you invested. Unless stated otherwise all yields are variable and neither capital nor income is guaranteed. If your employer offers a pension you should consider using this first. If you are on a low income and may rely on state benefits in retirement a pension scheme may not be appropriate. Taking benefits from an annuity or drawdown plan can also reduce some means tested benefits and income protection policies. The pension and tax rules are subject to change by the government. The earliest age at which you can normally take pension benefits is age 55. Tax reliefs and state benefits referred to are those currently applying. Their value depends on your individual circumstances. Before transferring a pension you should find out if exit or initial charges will be levied and then carefully consider whether you believe it will be beneficial for you to proceed and that the new benefits will be at least as good (ensure you will not be sacrificing guaranteed annuity rates or investment returns). You will be out of the market for a period of the transfer so you will not be affected by market rises or falls during this time. Loyalty bonuses will be available on the Vantage SIPP from 1 January This is published solely to help clients to make their own investment decisions; it is not a personal recommendation. If you are unsure of an investment s suitability you should contact a financial adviser for individual advice. Pension contribution checklist Most UK residents under 75 can contribute as much as they can afford to pensions and benefit from tax relief, however there are some restrictions designed to effectively limit this benefit. Please ensure you understand if you will be affected before making a contribution: 100% of earnings or 3,600: Personal and employee contributions paid in a tax year are limited to the highest of 100% of relevant UK earnings or 3,600. Relevant UK Earnings are measured in a tax year and can include salary, bonuses and profit from self-employment, but not investment income. Annual allowance: Could all pension contributions, including employer contributions, when combined over two consecutive tax years exceed 50,000? Will you have been a member of a final salary pension in the previous, current or next tax year? If you answered yes to either question you need to be aware of the 50,000 annual allowance. Vantage SIPP contributions count towards the annual allowance for the tax year in which they were made. E.g. a contribution paid to the Vantage SIPP in the 2012/13 tax year will count towards the 2012/13 annual allowance. Contributions to other pensions may count for the annual allowance in the following tax year. You should check with your provider towards which tax year s allowance your contributions count. Retirement benefits built up in a final salary pension are given a value that also counts towards the annual allowance. You should ask your provider what that value is. Any payments above the annual allowance may have a tax charge and cannot be refunded. You may be able to pay in more than the 50,000 annual allowance by carrying forward unused annual allowance from previous tax years. Please request our annual allowance and carry forward factsheet for more information. Lifetime allowance: This is the total amount you can accumulate in pensions. It is measured when benefits are taken from the pension and at age 75. All private and work pensions must be taken into account including any pensions from which you are already taking an income. The current allowance is 1.5 million. There may be a tax charge on any excess above this level. This could, for instance, affect those with a pension income of 60,000 to 75,000 a year. Enhanced or fixed protection: If you have applied to HMRC for enhanced or fixed protection against the lifetime allowance, further pension contributions will invalidate the protection. Recycling: If you significantly increase pension contributions in the year of taking tax free cash from a pension or in the two years before or after, this may be deemed as recycling of tax free cash and be subject to a punitive tax charge. This is a brief summary of the main restrictions; however it cannot cover every nuance and exception. You should seek advice if you think you may be affected by these limits or don t fully understand how they work. If you have any questions please call our pensions helpdesk. If you require advice they can put you in touch with an adviser. Annuity option: Although some annuity providers provide cancellation rights, these are only available for a limited time period and once the annuity is set up you cannot normally cancel it or switch to another provider. Annuity rates may change from time to time and are only guaranteed for a limited time period. Annuities are covered by the Financial Services Compensation Scheme. This can act as a safety net should an annuity company become unable to meets its annuity obligations. Income drawdown option: High income withdrawals may not be sustainable during the period you are in drawdown, prior to annuity purchase. Taking withdrawals may erode the capital value of the pension fund, especially if investment returns are poor and a high level of income is being taken. This could result in lower income when an annuity is eventually purchased. The investment returns may be less than those shown in the illustrations. Annuity rates may be at a lower level when the annuity purchase takes place. Investment in the SIPP will in most cases give you entitlement to the Financial Services Compensation Scheme (FSCS) in the event that we become unable to pay claims against us. In addition some, but not all of the investments you may hold within the SIPP wrapper will also be covered by the FSCS. For further information on the investments covered and the way in which the scheme operates please contact the FSCS. Moving into flexible drawdown will effectively prevent you making future contributions. Transferring an income drawdown plan may lead to a reduction in the maximum income that can be taken. All Options: Past performance is not a guide to future performance. All investments should be held for the long term as their value can fall as well as rise, therefore you may get back less than you have invested. This booklet is based upon our understanding as at September 2012 of pensions legislation. This is subject to change. The options described in this guide are those generally available however please note pension scheme rules can be more restrictive than the legislation. Hargreaves Lansdown - Income Drawdown 15