NEED TO KNOW GUIDE TO INCOME DRAWDOWN. Understanding your options

Transcription

1 NEED TO KNOW GUIDE TO INCOME DRAWDOWN Understanding your options

2 CONTENTS P3 WHAT IS INCOME DRAWDOWN? P4 WHY CHOOSE INCOME DRAWDOWN? P6 FLEXIBLE DRAWDOWN P7 CONSIDERATIONS P9 IS DRAWDOWN RIGHT FOR YOU? P10 CASE STUDIES 2

3 WHAT IS INCOME DRAWDOWN? Income Drawdown is a retirement option that allows you to draw an income from your private pension pot without the need to purchase an annuity. With recent government reforms offering retirees unprecedented access to their pension savings, income drawdown is now a realistic option for more people than ever before. How it works Income drawdown essentially puts you in charge of your private pension savings. While annuities require you to give over your savings in exchange for a lifetime income, drawdown lets you draw cash directly from your pension pot. The money you don t withdraw remains invested and you can control where it goes. Eligibility Eligibility to income drawdown has changed considerably in the past 12 months. New rules around Flexible Drawdown allow you to draw as much or as little as you like from your pension fund. Before April 2015, you had to demonstrate that you have a secure income of at least 12,000 per year from other sources. Since the rules were reformed, there is no need to show proof of alternative income to qualify for it. There is no formal minimum fund value for applying for drawdown, but it may not be suitable for you if you have a smaller pension pot. Due to the potential risks involved and the changing face of the current market - it is strongly advised that retirees seek independent financial advice before considering income drawdown as an option. 3

4 WHY CHOOSE INCOME DRAWDOWN? The key benefit of income drawdown is flexibility. When you buy an annuity, the terms you agree to at the outset usually can t be changed standard annuities are paid as a fixed rate that makes no allowances for inflation or personal emergencies. Unless you buy a guaranteed or joint-life annuity, your payments are stopped when you die and cannot be transferred even if the amount you ve received is far lower than the value of the pension pot you ve put in. With flexible income drawdown, you have considerably more control over how much you withdraw and when you can draw as much or as little as you like at any time. You can also make provisions to pass what remains of your fund on to a nominated dependent or organisation when you die. However, income drawdown does come with considerable risks. Because your fund is invested, you could see your pension pot shrink if these investments do not perform as well as expected. They also offer less security than annuities, and if your funds aren t managed carefully you could run out before you die. Tax free cash If you choose to go into drawdown, you can take up to 25% of your pension pot as taxfree cash. You might use this money to pay off existing debts, make a major purchase or even to buy an annuity while the larger part of your fund remains in drawdown. It s also possible to use this 25% tax-free allowance on all your income drawdown withdrawals, if you choose to deny the initial lump sum. 25% TAX-FREE CASH For these reasons, income drawdown is not an option that should be entered into lightly, though the added flexibility will appeal to many. Funds remaining are in the drawdown account 4

5 WHY CHOOSE INCOME DRAWDOWN? Drawdown or annuity? You don t necessarily need to make a straight choice between going into drawdown and buying an annuity. You could use drawdown to supplement other income sources during the early years of your retirement and buy an annuity when you re older and need more security. If your investments perform well while you re in drawdown, the size of your fund could increase allowing you to purchase an annuity with a higher rate of income. You can use your drawdown fund at any time to buy an annuity although you don t have to if you don t want to. 5

6 FLEXIBLE DRAWDOWN Flexible drawdown allows you to draw as much income from your pension pot as you like, whenever you like. You can choose to take up to 25% of your fund as tax-free cash, and the rest is charged at standard income rates. You can only take flexible drawdown after you have stopped paying into your pension. You cannot be an active member of a pension scheme or make any further contributions to a money purchase pension in the tax year that you apply for flexible drawdown. If you do make any contributions, your drawdown plan could lose its flexible status and any additional income payments or contributions made could be subject to your highest rate of tax. Requirements There are no requirements to enter income drawdown, though if your pension fund s value is quite low (i.e. less than 30,000), income drawdown may not be the best option for your retirement. Prior to April 2015, flexible drawdown was only available to people who could demonstrate that they had a secure pension income of at least 12,000 from other private pension or state pension income. Pension reforms In April 2015 many of the restrictions on flexible drawdown were lifted, making it considerably more accessible as an option. New products are still expected to enter the market, including income drawdown with guaranteed elements. In order to ensure you have the most up-todate information before making a decision, speaking to an independent financial advisor is strongly advised. A Note on Capped Drawdown Before pensions were reformed in April 2015, there were two types of income drawdown. Flexible Drawdown previously required you to provide evidence you were earning 12,000 in additional income to qualify. Capped drawdown allowed you to withdraw a set income from your drawdown fund every year, with the maximum income calculated at roughly 150% of the amount you could expect to receive from a relative value annuity. Since flexible drawdown is now an option for all retirees regardless of additional income, capped drawdown is no longer necessary. Pension providers have stopped offering this as a retirement option, though retirees who were in capped drawdown prior to April 2015 are able to continue with them in most cases if they wish. 6

7 CONSIDERATIONS As a retirement income option, going into drawdown has many potential benefits. However, there are also significant risks involved. It s important to weigh up the pros and cons carefully ideally with the insight of an independent advisor before making a decision. ADVANTAGES OF DRAWDOWN Less commitment When you use your pension fund to buy an annuity, there s usually no going back. You re tied into the agreement and vulnerable to any associated drawbacks for the full term of the agreement (which usually ends at your death for a standard annuity). Going into drawdown allows you to hedge your bets a little you can draw an income from your pension pot now and potentially buy an annuity later on (though you don t have to). Greater control Whereas most annuities tie you in to a fixed income, going into drawdown allows you to control how much money you draw at any given time. Flexible drawdown allows you to take as much or as little as you like. Opportunity to boost your fund with investments While you re drawing an income from your pension fund through drawdown, the rest of your pot is held in investments. If your investments perform well, the overall size of your pension fund could increase significantly. However, it s important to bear in mind that if your investments fail to meet expectations, your pension pot could also shrink. Better opportunity to protect against inflation Because most standard annuities offer a fixed income for life, a major drawback is the danger that the realworld value of your income will become significantly less over the years due to inflation. In drawdown, if your investments perform well, your fund could grow at a rate that matches or even exceeds inflation. Once again though, it is important to be aware that this is by no means guaranteed. 7

8 CONSIDERATIONS Funds can be passed on when you die Another major drawback of annuities is the fact that in most cases your payments cease when you die, and if the total income you have received is less than the value of the pension fund you used to buy it, the shortfall is lost and cannot be transferred or passed on to someone else. Annuity products that do offer death benefits (such as joint life annuities and guaranteed annuities) can be expensive, and only offer limited protection. By contrast, with drawdown it is relatively easy to pass whatever remains of your pension fund to your partner, dependent or any other nominated beneficiary and you don t need to make the decision up-front. DISADVANTAGES OF DRAWDOWN Lack of security The key benefit of an annuity is security the income you receive is guaranteed for life. By comparison when you go into drawdown there is no guarantee that your pension pot won t run out before you die. Poor market conditions, taking more than you can afford or simply living for longer than you expected can see your fund erode over time. If your pension pot is likely to be your sole source of income in your later years you should think very carefully about whether income drawdown is the right choice for you. More complex Because drawdown involves making investment decisions that may require regular reviews, it can be an intimidating option for people who are risk-averse or don t consider themselves to be particularly financially savvy. Even if you do have experience with savings and investments, you should always seek the advice of an independent financial advisor who specialises in pensions and retirement planning. Potentially expensive The cost of regular pension reviews and working with an advisor could eat into your pension pot in itself. For this reason, drawdown may not be the most cost-effective option for people with smaller pension pots (i.e. less than 30,000). Vulnerable to the market In addition to the risk that your investments might lose value if they fail to live up to expectations, if you decide that you want to go into drawdown now with an eye towards buying an annuity in later life, you could find that annuity rates fall in the future depending on how the market performs. However, to balance this concern it s worth remembering that it s generally possible to attract better annuity rates later in life than you would in early retirement, as providers calculate that they won t be paying an income to you for as long. Unpredictable Because your pension pot is held in investments, there is no way to predict with 100% accuracy how the market will perform. If your investments perform badly, you could see your pension pot shrink dramatically. 8

9 IS DRAWDOWN RIGHT FOR YOU? In light of the recent reforms to the pensions market, income drawdown is becoming an increasingly popular retirement income option. However, it is not suitable for everyone. Generally speaking, income drawdown may worth considering if: You have a larger pension pot ( 40k+). You have other income streams or are in a position to weather potential fluctuations in your income. Maintaining control and flexibility over your pension pot is a high priority for you. You are financially savvy and comfortable making your own investment decisions. You are willing to accept a degree of financial risk for the opportunity to increase the size of your pension pot. You are happy to accept the cost of reviews and administration that drawdown entails. Transferring what remains of your pension pot to a partner or dependent in the event of your death is important to you. Income Drawdown may not be the best option for you if: You only have a small pension pot ( 30k or less). Your personal pension pot is likely to be your sole significant source of income in later life. You prioritise security and a dependable income over flexibility and the opportunity to boost your pension pot. You re not comfortable with making investment decisions or working with financial advisors. Remember that this guide is for information purposes only and does not constitute advice. Individual circumstances and priorities may vary. If you re unsure whether or not income drawdown is right for you, speaking to an independent financial advisor can help you to get a clearer view of your options. 9

10 CASE STUDIES: FOUR WAYS TO DRAW AN INCOME THROUGH DRAWDOWN For illustrative purposes only, here are four brief examples of how income drawdown might be managed as part of a retirement income plan. SCENARIO 1: SCENARIO 2: Natural Yield: Michael ( 250k) Michael retires aged 65 with a pension pot worth 250k. He is keen not to erode his pot too much over the years. Working with an advisor, he makes investments that are predicted to make a high enough return for him to live on without touching the underlying capital. There is still a risk that income could fall in adverse market conditions, but by spreading his investments carefully, Michael is comfortable that he is minimising this risk and on balance he is happy that he isn t using up any of the underlying capital at all during times when his investments are stable. Occasional withdrawals: Susanne (100k) Susanne has a 100k personal pension pot and lives with her husband, who has a sizeable pension income of his own. Because her husband s pension income, alongside external income from other investments they ve made over the years is enough to comfortably cover their living costs, Susanne decides to keep her personal pension pot in drawdown as a rainy day fund. She takes her 25% lump sum to pay off their remaining mortgage, and keeps the rest held in a drawdown plan in low-/mid-risk investments, taking only very occasional ad-hoc withdrawals. So long as she and her husband can rely on their other income streams - and she keeps a close eye on the size of her fund - this plan allows her to minimise the potential strain on her finances in case of an unanticipated emergency. 10

11 CASE STUDIES SCENARIO 3: SCENARIO 4: Delayed withdrawals: Abdul (80k) Abdul has a mid-size pension pot of 80k, and is conscious of the fact that his reliance on this money may increase as he gets older. As he is still in good health and working part-time, he decides not to touch his pension fund yet, placing it in drawdown and working with an advisor to spread the cash across a range of low-/high-risk investments. He is hopeful that he can increase the size of his pension pot by the time he comes to need it though he accepts the possibility that this may not happen. When he no longer feels able to work, he intends to buy an annuity in hopes of claiming a higher rate of income. High withdrawals over a short period of time: Anne (150k) Anne is not dependent on her personal pension pot due to other income streams, so she decides to take the full amount in cash to help her daughter to get on the property ladder. In order to avoid paying an excessive tax rate, she goes into flexible drawdown and works out a plan with her advisor to withdraw the full amount in stages over a five-year period. This allows her to get better value from her fund than if she took it all as cash up front and accepted the top rate of 40% income tax. As time goes on he gradually reduces the investment risk in his fund so he can continue to make realistic plans for the future without worrying about any unwelcome surprises. 11

12 This income drawdown guide is provided in association with the Financial Advisor Network. The content of this guide is for information purposes only and does not constitute formal advice. We endeavour to keep this guide as up-to-date as possible, but it is important to speak to an independent financial advisor to gain the most accurate picture of your personal retirement options. If you have any questions about income drawdown, or would like to be put in touch with an independent advisor for a free initial consultation, please call our customer helpline on or info@mypensionchoices.com