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A Drawdown policy is aimed at those people who do not want to buy an annuity and thus lock themselves into an inherently inflexible arrangement.
Drawdown allows you to leave your pension fund invested after you have taken the tax free cash sum and to draw an income from the invested fund.
The first step is to consolidate all your existing pension funds into one pot, a Personal Pension. The second step involves taking your maximum tax free cash (possibly 25% of your fund) up front as a lump sum and then drawing the income you need each year directly from your pension fund, rather than buying an annuity. This is the important principle behind Drawdown - your income is paid from your residual fund, not from buying an annuity. All the problems associated with buying an annuity can be forgotten.
The income drawn from the fund is taxed as income in the same way income from an annuity is.
The money left in your residual fund remains invested in your Drawdown policy until you are ready to take it out as income. You can carry on doing this until you are 75, then under current legislation you must buy an annuity with the money left in your residual fund.
There are limits set down by the Government (known as GAD rates) which set the maximum and minimum amount of income you are allowed to draw. Our advisers will explain how these limits work and why the Government has felt it necessary to set these limits.
Drawdown has many advantages over the traditional retirement options.
- You can increase or decrease your income (within the limits set by the Government) at your discretion. In theory you could change your income level each month.
- Your residual fund remains invested and hopefully grows in value.
- You can defer the purchase of an annuity until you are 75.
- In the event of your death, your spouse or dependants have a much wider set of options including receiving the whole of the value of your residual fund as a lump sum, less a special rate of tax at 35%.
There are also drawbacks associated with a Drawdown plan. The returns on income Drawdown policies depend on investment performance and therefore:
- Your income isn't guaranteed.
- The value of the fund can go down as well as up.
- If the value of the fund falls, it is possible that the maximum allowable income will also decrease.
- GAD rates depend on gilt yields which have been falling over the years and this may also result in the maximum level of income allowable decreasing.
- If annuity rates continue to fall, delaying buying one may mean that despite being older, you will receive less income from your annuity (when you finally buy one) than if you had purchased one straight away.
Our experienced advisers will be able to explain this complex subject and help you make an informed choice about how best to draw your pension benefits.
Comparing features of phased retirement and income drawdown
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