Drawdown and Flexi-Access Drawdown Pensions
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Drawdown and Flexi-Access Drawdown Pensions
Kwasi Yeboah talks all about pension options.
What exactly is a drawdown pension?
Perhaps it is best to start with a bit of context. Back in 2015, the government decided to change the way that people could access their pension benefits on retirement, and this increased the options available. Now, you are no longer required to take a set income, you can take as little or as much at any one point as you like.
The term drawdown means exactly that – you are drawing down your pension savings.
There are two forms of drawdown: capped drawdown, which was available prior to 2015, and flexi-access drawdown. The former only allows you to take income from your pension within a very strict limit. The latter can be changed more widely to suit an individual’s needs at a given time.
What is a flexi-access drawdown pension?
These days, most pension savings are in what are known as defined contribution pensions. This is where you – and in some cases, your employer – put in money that is invested to (hopefully) grow. At the time you come to take your pension, hopefully there will be a big pot of investments to provide you with an income in retirement.
At retirement these investments can be sold and turned into cash, and you can take the money out and spend it on whatever you need. Many people will be familiar with annuities. Back in the day, the value of your pension pot would be used to buy an annuity, which would provide an income for life. Now, these were, and are, very rigid.
With a flexi access drawdown pension, you can cash in a portion of the investment as and when you like.
What are the benefits of drawdown and flexi-access drawdown pensions?
The first thing to note is that capped drawdown pensions are only available to those who took them out prior to 2015. So if you are coming up to retirement now and considering your options, capped drawdown pensions will not be included.
The main benefit across capped drawdown and flexi-access drawdown pensions is that the bulk of your pension savings remain invested. That means they can continue to grow even while you take money out. That is a huge benefit.
Another benefit of a capped drawdown is that you cannot take out too much at any one time and run the risk of getting through your pension savings too quickly. If you do take out more than the cap, your pot will automatically be converted to a flexi-access drawdown pension.
The obvious benefit of a flexi-access drawdown pension is its flexibility. Perhaps there is a certain life event in your retirement which means that you will need a little bit more money.
You can do that with a flexi-access drawdown pension.
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Are there any disadvantages to drawdown pensions or flexible access drawdown pensions?
Flexi-access drawdown pensions can be comparatively expensive as opposed to, say, purchasing an annuity. It is partly because the funds remain invested, which requires some management. Taking semi-regular withdrawals comes with some administrative costs as well.
It is all about working out which of the many options are most appropriate for you. On balance, despite the charges element, there are relatively little disadvantages with flexi-access drawdown pensions.
When is it a good idea to have a drawdown or flexi-access drawdown pension?
You can no longer elect to have a capped drawdown pension. It is a good idea to have a flexible access drawdown pension if you anticipate your income needs in retirement may fluctuate.
It is also probably more suitable for a larger pension fund, perhaps in excess of about £100,000 because there are additional costs involved.
What other ways can you take your pension?
In addition to the two we have discussed today – capped drawdown and flexi-access drawdown, there is also the option of purchasing an annuity. That was very common twenty or thirty years ago, but still remains an option to consider. Annuities may be appropriate for individuals who want a fixed guaranteed income for the rest of their lives.
There is also the option of taking what is known as an uncrystallized funds pension lump sum, which is in many ways very similar to a flexi-access drawdown. The difference is that you are taking lump sums rather than an income over a given period of time.
Then, of course, there is the option to take your entire pension pot in one go. Now, in most cases, this is not advisable, but might suit people if they have a small amount of pension savings and there is little sense in taking it in dribs and drabs.
Lastly, there is the option of not taking your pension at all. Pension savings make great estate planning tools as they remain outside of your estate. Now, for some people, this may be an option that they would like to explore.
How much tax will I pay?
Pension income is taxable as earned income. That means that the vast majority of your pension income is taxed at standard rates: 20% for a basic rate taxpayer, 40% for a higher rate taxpayer and 45% for an additional rate taxpayer.
Most people, however, can take the first 25% of their pension tax free. Some people like to do this upfront, i.e. at retirement, but you can take your tax free cash from any age after 55. The remaining 75% is taxable at your marginal rate.
Another option is for 25% of each withdrawal to be tax free. Some older pensions may have a higher tax free cash figure, in excess of 25%. These benefits can be lost on transfer to a new provider. So it is always worth getting professional help before transferring any old pension pots.
How can First Thought Financial Services help?
First Thought Financial Services is part of the Quilter Financial Planning network, which itself is a part of Quilter Plc, a FTSE250 company. Our relationship with Quilter means we can provide extensive retirement planning solutions, including flexi-access drawdown pensions.
Our advisers can help you put in place a drawdown strategy and ensure that the plan is reviewed regularly to make sure that it remains appropriate.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.
Tax treatment varies according to individual circumstances and is subject to change.