Income Drawdown
Income drawdown plans were introduced in 1995. The changes removed the requirement to purchase an annuity at retirement. Income drawdown allows an income to be taken directly from the pension fund itself.
Unlike Phased Retirement the income is taken direct from the fund. The maximum level of income is set by the Government Actuary's Department (GAD) based on the size of the fund, age, sex and current gilt yields. The GAD rate is broadly equivalent to the equivalent single life annuity that you could have purchased. The maximum income can be no more 150% of the GAD rate. The rate is reviewed every 3 years.
Since April 2015 there is now much greater freedom to choose how you use your pension fund and the rules regarding income drawdown are now largely irrelevant as there is so much flexibility in how you withdraw money from your pension. See New Rules About Pensions.
Income Drawdown / Fund Withdrawal
Income drawdown is an important option to consider when you're coming up to retirement, but it pays to have an understanding of the pros & cons.
Income drawdown plans came about following changes to the law in 1995. The changes did away with the requirement to buy an annuity as soon as you retired, instead allowing you to start taking an income directly from the pension fund itself. It gives you the flexibility to defer the purchase of an annuity to a time that better suites you. Most of the major insurance companies now offer drawdown plans. They work in just the same way as ordinary plans, allowing you to contribute throughout your working life to build up a retirement fund, however upon retirement you will have two options:
- Take 25% of the fund as tax-free cash & invest the rest into an annuity, just like an ordinary plan.
OR
- Take 25% of the fund as tax free cash & draw an income from the rest of the fund instead of buying an annuity.
If you choose to take the withdrawals, there are upper and lower limits based on what the government thinks an average single life annuity would have paid you. You can stop withdrawals at any time, and use remaining fund to purchase an annuity, but in any event, an annuity must be purchased with the remaining fund by your 75th birthday.
Like phased retirement plans, income drawdown plans carry heavier management charges than ordinary policies, as a result they are also only really suitable for larger funds.
Advantages
Like phased retirement, pension fund withdrawal gives you control over when you commit your pension fund to an annuity, right up to your 75th birthday. This can be an advantage if rates are particularly low when you come to retire. In addition, annuity rates improve in relation to age, so the older you get, the better your annuity rate could be.
Within certain limits, you have the flexibility to adjust your annual income to levels that suit you. All the while, the fund continues to benefit from it's investments. If these are favourable, & your income withdrawals are not too high, your fund could even continue to grow until you finally purchase an annuity. In other words it may be possible to take an income & still see your pension fund rise in value.
An ordinary single life annuity stops paying when you die. This could be disastrous if it happens very early on in retirement & a spouse is left. With pension fund withdrawal, all of the remaining fund passes onto your estate, albeit subject to inheritance tax. If you have a spouse, they would be free to use the fund to provide their own annuity. If you don't need the income in the early years, & you have a spouse to leave the fund to, income drawdown could well be suitable.
Disadvantages
Like phased retirement, pension fund withdrawal does not guarantee better annuity rates in the future. There is always the risk that annuity rates will worsen in the future, which will of course result in lower income. Furthermore, unlike phased retirement, you must take some income from the fund, so the fund is always being depleted. If the withdrawals are high the problem is exacerbated. High withdrawals & poor investment returns are a recipe for disaster. For this reason, pension fund withdrawal is usually only suitable for people who can afford to take close to the minimum amount of income allowable.
The same is true of the remaining pension fund. Whilst drawing income, the fund itself is susceptible to the rises & falls of their underlying investments. This could result in your fund shrinking which would obviously affect the annuity income you could buy. Even if investment performance is only poor for a few years, it could have a disastrous effect on your eventual pension income.
The costs associated with pension fund withdrawal plans are higher than those of an annuity.