Pension drawdown (or Flexi-access pension drawdown to give its full title) was introduced as part of the pension freedoms (April 2015). The freedoms delivered greater flexibility for those approaching retirement but also another level of complexity. In this post, we attempt to answer the most common pension drawdown questions.
What is pension drawdown
Prior to the pension freedoms (April 2015), the majority of those with defined contribution type pension schemes exchanged their pension fund for an Annuity at retirement. The Annuity paid a fixed pension each month for life.
Pension drawdown delivers the flexibility to make withdrawals from a pension fund as required. There is no fixed payment each month.
The pension fund holder is responsible for managing withdrawals and ensuring the fund lasts through retirement. Withdrawals may be in the form of tax free lump sums, taxable income or a combination of the two.
In principle, any defined contribution type pension may be converted to flexi access pension drawdown although a number of restrictions do apply. Moving a pension into drawdown is not always the best option and it is important to take advise (or at least consider carefully) on what the best way forward may be.
Can I revert back from annuity to drawdown
No. When you buy an Annuity you buy a contract for life. It is currently not possible to sell an Annuity.
However, it is possible to use part (or all) of a drawdown pension fund to purchase an Annuity if/when it is appropriate.
Can I enter pension drawdown before I am 55
It is not possible to access pension funds before reaching age 55. Beware of anyone who may try to persuade you otherwise.
As it is necessary to access an existing pension fund to transfer it into drawdown it is not possible to set up a drawdown plan until reaching 55 years old.
Can I run out of money in drawdown
Yes, you can and this is one of the major risks of the pension drawdown approach. Income from a pension fund in drawdown is not guaranteed. The value of the pension fund can rise and fall depending on the performance of investments and the economic and political environment. If not properly managed withdrawals can deplete a drawdown fund to zero during retirement.
What is the average cost to manage a drawdown pension
Costs vary considerably and it is very important to choose the right solution to suit personal circumstances. High fees can deplete the value of a drawdown pension fund over time.
There are a number of fees and it can be difficult to compare costs between providers. Charges are usually based on a percentage of the fund value. Percentage charges may be higher for lower value funds.
Given the above, it is difficult to provide an estimate of costs. Annual charges may be anywhere between 0.3 and 1.75% of the fund value. There may be several set up charges and various trading charges on top of the annual charge depending on the provider.
Do you get taxed on a drawdown pension
The short answer is yes. 25% of the pension fund value taken into drawdown is available tax free. Any withdrawals on the balance will be taxed as income at your marginal rate.
Can I still save into a pension in drawdown
Yes. It is possible to take a pension fund into drawdown, take the 25% available tax free and continue to pay into the drawdown pension fund. If only the tax free sum is released the normal pension investment rules apply*.
Once income is taken from the drawdown fund (over and above the tax free sum) the maximum amount that may be invested in the drawdown fund drops to £4,000 in any tax year.
* As much as total annual salary may be invested in a pension in any tax year up to a maximum of £40,000.
What are the benefits of pension drawdown
Pension drawdown delivers control over your pension fund. You determine what level of risk you are prepared to take on investments and the withdrawals you make. Unlike an annuity, you may vary your income perhaps drawing more in the early years of retirement and less later.
With drawdown, you have control over remaining pension fund distribution to beneficiaries after your death. There is no inheritance tax but the taxation position does vary depending on if you die before or after age 75.
It is important to note there are also risks associated with pension drawdown.
How do I set up a drawdown pension
If your existing pension cannot facilitate “drawdown” you will need to take your existing pension fund and transfer it into a different pension fund that you manage. A pension fund is often transferred into a Self Invested Personal Pension (SIPP). A SIPP can accept a wide range of assets investments and you are responsible for managing those investments to maximise growth while minimising risk. You may draw on the fund held in the SIPP as you wish.
You should carefully review your existing pension fund before transfer to ensure you do not leave behind any valuable benefits as a result of the transfer. You should also note the pension provider may impose fees before they will allow access to the pension fund.
How will my income be taxed
At the point you move a pension into Drawdown you may take up to 25% of the fund value tax free. When the remainder of the pension fund is accessed it is classed as income and will be taxed at whatever your marginal tax rate may be.
With drawdown do I still get a monthly pension
Before flexi-pension drawdown was introduced in 2015 the pension option taken by most at retirement was an annuity. It is important to not confuse an annuity which pays a set pension income each month for life with a drawdown arrangement which does not.
Of course, a drawdown pension fund is under your control and you may set it up to pay you a set amount each month if you wish. However, with drawdown, there is no guarantee the pension fund will last a lifetime.
Do I have to pay fund management fees in drawdown?
Yes, your pension fund is an investment and therefore investment management fees apply. Fund management fees typically include an investment management charge, your financial adviser (if you have one) charge and a platform fee (if applicable).
What is best – pension drawdown or annuity?
It very much depends on your personal circumstances and your attitude to risk. Annuities guarantee a fixed income for life. You cannot outlive your pension fund, however long you live. ‘Joint-life’ annuities will also pay a spouse a pension until they die but there is no value to potentially pass on to children.
Annuity values, and therefore the amount they pay per year, have generally been poor over recent years which can make drawdown a more attractive option. Pension drawdown gives you more control both in how you take your income and how the balance is invested. It is also possible to pass on any remaining pension fund when you die to your spouse or children.
You may take as little (or as much) as you like in drawdown but there is no guarantee your pension fund will last through your retirement. Unlike Annuities, you are responsible for carefully managing your pension fund and investments.
Can I move to drawdown from my final salary scheme
Not directly. Flexi pension drawdown was set up specifically for those with Defined contribution (money purchase) type pension schemes. Those with Defined Benefit (final salary) pension schemes were excluded.
Should an individual with a final salary pension scheme wish to access pension drawdown they first need to action a pension transfer from their final salary pension scheme to a defined contribution type scheme set up for the purpose.
Note: The Financial Conduct Authority (FCA) advice is that a transfer out of a final salary pension will be unsuitable for the majority of individuals.
What are the risks of pension drawdown
Pension drawdown does carry significant risks. There is a risk of running out of money in retirement. You need to actively manage your investments, or pay someone to do it for you.
Annuities are simple to understand and need minimal management. In contrast, drawdown can be difficult to understand and mistakes can have major consequences. Poor investment decisions could result in your pension fund dwindling rapidly.
Can I move a pension in drawdown to another provider?
Yes, this is allowed but HMRC rules dictate so you must move the entire fund from one provider to the next. It is important to note the existing provider may charge a fee to facilitate the transfer to the new provider.
Do I have to move all my funds into drawdown at the same time
No. If you have several pensions you may move one or more into drawdown while leaving the remainder where they are.
With several pensions, you may mix and match if that best suits your requirements. Some you may move into drawdown, some you may leave where they are and some you may convert to an Annuity.
If I choose drawdown can I still take a tax free sum
Yes. As you move a pension into drawdown you may take all (up to 25% of the pension fund) or part of the tax free sum. If you have several pension funds and you wish to move several into drawdown you may take a tax free sum on each pension you transfer into drawdown.
Can you have more than one drawdown pension
Yes, this is possible but this approach may increase total fees. It may also make management of your pension funds more difficult.
What happens to my drawdown pension fund when I die
Any pension funds remaining in your drawdown fund at your (and your spouses death) may be passed on to beneficiaries without inheritance tax. The tax position depends on your age at death. If death is before age 75 then what remains in the pension fund is passed on tax free. If death is after 75 your beneficiaries will be taxed on the pension fund value at their marginal tax rate.
What is maximum pension drawdown
There is no restriction on the amount that may be taken (withdrawn) from the available pension fund. You may take your entire pension fund (if you are over 55) in a drawdown arrangement but it is important to be aware of the tax implications.
There does appear to be some confusion as under the old rules (prior to April 15) only capped drawdown was available which, as the name suggests, placed restrictions on the amounts that could be taken from the pension fund in each tax year. Those in capped drawdown may remain with this product but it is not available (after April 15) to new entrants.
Can I alter the level and frequency of my income payments
Yes, once over 55 years of age you may take whatever income you require whenever you wish. It is important to note whatever withdrawal is made will be liable for tax.
Remember your pension is not a magic money tree. Failure to manage the level of withdrawals may mean your pension fund is depleted leaving you totally reliant on whatever state provision may exist at the time.
Where can I invest my drawdown pension
A pension drawdown fund must be invested in an HMRC recognised defined contribution type pension fund. There are many options available (Including SIPP’s) each with their own mix of assets, fees, charges, risks and growth profiles. It is vitally important to choose wisely.
Can I move to drawdown from my final salary scheme?
Not directly no. First, it is necessary to transfer out of the final salary scheme exchanging your pension entitlement for a cash sum. This sum may then be invested in a defined contribution (pension drawdown) scheme of your choice.
Careful consideration should be given to any potential final salary pension transfer. In 2018 Christopher Woolard, FCA’s Executive Director of Strategy and Competition said “Defined benefit pensions are valuable so most people will be best advised to keep them”
Can you take lump sum from a pension but delay drawdown
Yes, and depending on personal circumstances it may be in your best interests to do so. Currently, a UK taxpayer under the age of 75, can contribute an amount up to their maximum annual earnings each year to their pension subject to a cap. The cap is usually £40,000 per annum but can vary and should be checked based on your individual circumstances. Once a tax free sum is taken and first income is taken from the drawdown fund this maximum limit drops to £4,000 per annum.
What happens to my drawdown fund on my 75th birthday
There are three issues to consider inheritance, the Lifetime allowance (LTA) and your pension drawdown terms. Taking inheritance first If you die before age 75 any beneficiaries may inherit your remaining pension pot tax free. After age 75 they may still inherit but will pay tax on any amount taken from the remaining pension fund at their marginal tax rate.
A test will be made against the Lifetime Allowance once you reach age 75. This test includes investment growth of the drawdown plan from day 1 to reaching age 75 but is only relevant if your total pension funds exceed £1 million. The issues surrounding the LTA are complex so if it does apply it is important to seek professional help to determine the best way forward.
What is pension crystallisation
When any amount is withdrawn from a pension its tax status is changed. It is crystallised in part or in full. What is (and is not) a crystallisation event is defined by HMRC. At each crystallisation event the total value of your pension fund (all pensions) is tested against the LTA.
Different tax and inheritance rules apply to the crystallised and uncrystallised amounts. This can be a complex area and it is important to take professional advice.
When will my drawdown fund be tested against LTA
This is a complex subject and it is best to take financial advice. In simple terms, the first test is applied when taking a pension fund into drawdown. A second test is applied when the pension holder reaches 75 years old or when the drawdown fund is used to purchase an Annuity.
Do I have to get advice before entering drawdown?
No. There is no legal requirement to take Financial Advice before entering drawdown. That said retirement decisions can have major long term financial consequences so it is important to take the time to consider carefully if taking advice would be the best way forward. There are free (government sponsored) financial guidance services available that may help.
We hope the above answers your immediate questions. Come back to this post regularly as we will add more pension drawdown questions and answers over the coming weeks and months. Should you have questions we have not answered above or are in need of further detail then please do not hesitate to contact us on 0800 043 8341.
The value of investments can go down as well as up and you may not get back the full amount you invested. The past is not a guide to future performance. This blog is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investment or course of action. Tax regualtions can change and any figures quoted above are at the date of publication.