Flexi-Pension Drawdown has become an increasingly popular alternative to an annuity. But for those who wish to consider drawdown as an option, the pension drawdown rules and regulations can be complex and difficult to understand. It is impossible to cover all the issues in a short post but we can provide a top level overview covering the main points..
Pension Drawdown Rules – The Basics
First, it is important to note that it is not possible to access any funds from a pension scheme until you are over 55 years old unless there are special circumstances (such as serious illness). As a first step it is important to familiarise yourself with the pros and cons of pension drawdown and the drawdown process.
When you transfer a pension into a Drawdown arrangement you may take up to 25% (see below) of the fund value tax free. You may then access the remaining fund as you wish to fund your retirement. Any remaining fund on your death may be past on to beneficiaries tax free in some circumstances.
Flexi-pension drawdown only applies to defined contribution schemes not defined benefit (final salary) pension schemes. More on how those with Final Salary Pensions can access drawdown below.
Taking A Pension Into Drawdown
Your existing pension provider may offer a drawdown solution. If not it will be necessary to transfer the pension to another provider. It is vital to check you are not giving up valuable benefits when transferring a pension. It is also important to shop around for the best deal. Do not assume any drawdown package offered by an existing pension scheme provider is the best available. If you have only a small pension pot drawdown may not be the best option for you.
You may have several pensions but you do not need to transfer them all into Drawdown at one time. You may plan to take some pensions into drawdown and convert others to an annuity. You may choose to consolidate all your pensions into a single Drawdown fund. You may take one (or more) pensions into Drawdown while delaying decisions on others to a later date. It all depends on your personal circumstances and your retirement plan.
If you take the drawdown option it is possible to convert any remaining funds in drawdown to an annuity at some point in the future. It is not possible to convert an existing annuity to drawdown.
Managing Your Pension Fund
After tax free sums have been taken (see below) the remainder of your invested drawdown fund may be accessed to fund your retirement. There are no limits on withdrawals, you may even withdraw the full amount if you wish. Anything you do take from the fund will be taxed as income at whatever your marginal tax rate may be.
Remember your pension funds need to last you a lifetime. If your drawdown fund performs poorly as an investment and/or withdrawals are not carefully managed you could run out of money in retirement.
You can top up your pension fund if you continue to work (full or part time). However, once income has been taken from a drawdown fund tax limits do apply (see below)
Twenty-five percent of the value of each pension taken into Drawdown is available tax free. All the tax free element does not need to be taken at one time. If the full tax free amount is not taken then pension crystallisation can become an issue. What is (and is not) a crystallisation event is defined by HM Revenue and Customs. This is a complex area beyond the scope of this post.
Should you wish to continue to contribute to a defined contribution pension plan then limits apply. If you take up to the maximum tax free cash but do not drawdown an income from the pension fund then you may pay up to £40,000 into your pension (or your maximum yearly income if this is a lower value) each year and receive tax relief. If you have made withdrawals from the Drawdown pension fund (after tax free cash) that allowance drops to £4,000.
There is a limit on how much may be withdrawn from a total pension fund without triggering an additional tax charge. That limit is known as the Lifetime Allowance (LTA) and is currently set at £1.03 million. This is not an issue for many but if you are nearing the limit for contributions to a defined contribution pension plan it is important to take professional advice.
Looking After Beneficiaries
A major advantage of drawdown is you may leave any remaining pension funds to beneficiaries after your (and your Spouses) death. No inheritance tax is payable in most circumstances.
Your beneficiaries have various options on how they access the fund. Their tax liability depends if you die before or after age 75 years.
Final Salary pensions
To access the potential benefits of pension drawdown a holder of a final salary (DB) pension must transfer pension benefits to a Defined Contribution (DC) scheme. This is not the right move for most and there are significant risks. We have covered Final Salary Pension Transfers elsewhere on our website.
Consideration of pension drawdown should be undertaken as part of a retirement planning exercise. There are other pension options and drawdown may not be the best way forward for you given your personal circumstances. If Drawdown does become part of your approach you will need to research the best deals available and consider fees and charges. If you are considering entering into a drawdown plan we recommend that you seek financial advice before you do so.
Download our free Drawdown guide to learn more or visit our frequently asked questions (with answers) page. Alternatively, complete the contact box below and one of our advisers will email an answer (without cost or obligation)
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 regulations can change and any figures quoted above are at the date of publication.