In this blog I will look to answer the question What is drawdown?
Pensions have 2 different phases:
- the growth phase – while you are working, you pay into your pension and want to grow the fund value
- the income phase – where you use your pensions to generate an income usually in retirement Drawdown falls into the latter.
What is drawdown?
Drawdown is a manner in which income can be facilitated during retirement. Unlike an annuity (see my previous blog What is an annuity?) drawdown does not pay a guaranteed income. Your money remains invested and you can withdraw your money in pretty much any manner. The main thing to bear in mind is that if you take out too much money, your fund could run out.
When taking benefits from a pension, 25% of the fund is tax free and 75% taxed as income. Traditionally, the 25% was taken as a lump sum however, it doesn’t have to be. This tax free element could be taken as part of the income. For example, if you wanted £10,000 per annum, £2,500 could be the tax free element and £7,500 taxed.
Drawdown allows you to take out as much or as little as you want. To take a lump sum up front or in traches. It is very flexible and very good for taking income tax efficiently.
There are different types of drawdown:
- Capped Drawdown
- Flexi-access drawdown
- Uncrystallised Pension Lump sum
Capped drawdown is the manner in which drawdown was facilitated before April 2015. People who had commenced taking benefits before this date may still be in capped drawdown. Capped drawdown does what it says. It caps the amount of income that can be drawn from a pension based upon: the individuals’ age, their fund value in drawdown and Government Actuarial Department (GAD) rates (essentially the prevailing annuity rates for someone of the same age at the time). Individuals can take 0-150% of GAD. Capped drawdown is reviewed every 3 years for those under 75 and annually for those over. This means that their allowable income could go up or down at review.
If the GAD maximum and therefore the cap is exceeded, you will move into Flexi-access drawdown.
Flexi-access drawdown (FAD) was introduced in April 2015 with the Pension Freedoms reform. The basis of the plan is still the same however, there is no cap on the income that can be taken from the plan. Therefore, if someone wanted to take 100% of their pension out, they could. However, this may not be wise for a number of reasons, not least the fact that 75% of the fund value would be taxed. For example, if someone had a fund value of £100,000, 25% – £25,000 would be tax free and 75% (£75,000) would be taxed. Therefore if you had no other income in the same tax year, this would cost £18,696 in tax!
I have met with a number of people since April 2015 who have wanted to take all of their money out of their pensions to “put into their savings”, “so it was theirs” or “to get capital growth”. None of these are good reasons to take money out of a pension and quite frankly, it is a bit of a silly thing to do. If you are thinking about taking your money out for one of the reasons listed above or any other reason, PLEASE speak to an Independent Financial Adviser first.
By taking income via FAD, you will trigger the Money Purchase annual allowance which restricts the amount you can pay into a pension to £4,000 each year. If you have done so, you must inform all of your pension providers.
Withdrawals can be taken via FAD as lump sum(s) or income with either all of the tax free cash paid up front or in sections.
Uncrystallised Pension Lump Sum
Uncrystallised Pension Lump Sum (UFPLS sometimes pronounced uffplus – not sure why) is a bit like FAD however, it allows you to take the whole plan or bits of the plan as lump sums. For example if the fund value was £100,000 and you wanted £20,000. This would be paid as a lump sum with £5,000 as the tax free cash and the £15,000 taxable as income.
By taking UFPLS you will trigger the MPAA (the £4,000 restriction to payments in).
In this blog, I have answered the question What is Drawdown? And looked at Capped Drawdown, Flexi-access Drawdown and Uncrystallised Pension Lump Sum. What these are and the type of income that they facilitate as well as some tax implications and reasons not to take all of your money out of your pension. Drawdown is very complex area and within this blog there is not the scope to cover the full details of what needs to be taken into account when considering drawdown. I strongly recommend speaking to a Financial Adviser.
If you are approaching retirement and would like to understand your options, do contact me for a complimentary no obligation initial meeting.