Income Drawdown Pension is a method of withdrawing benefits from a pension fund without purchasing a lifetime Annuity. This type of plan is aimed at the more financially aware investor and tends to attract the larger pension funds. The minimum amount that can be invested varies from Company to Company and benefits are currently available from age 55 onwards.
Personal pension plan holders can defer taking their Pension in the form of an Annuity and instead make withdrawals directly from the pension fund. This option only applies to a Personal Pension and not to a Retirement Annuity Contract, unless it is first transferred to a personal pension.
Aims of Drawdown Pension
The main purposes of Drawdown Pension can be summarised as follows:
- Deferral of Annuity purchase, thus avoiding being locked into low Annuity rates which may apply at the time of Retirement.
- The Drawdown Pension option enables the policy holder to buy an Annuity at a time that is best suited to them and hopefully when Annuity rates are more favourable or provides an opportunity to avoid purchasing an Annuity altogether where appropriate.
- The option enables investors to retain control over their pension investments and allows them to continue to be invested in the markets.
- It postpones the decision of deciding which type of Annuity to lock into e.g. providing a contingent pension for a wife or husband and selecting a level or increasing pension.
- It enables any remaining pension fund on death to be paid to your beneficiaries as a lump sum less a tax charge of 55% (if there are no dependants the lump sum can be paid to your nominated charity free of the tax charge). Funds used to provide a dependant’s annuity will not be subject to this tax charge – the annuity will however be taxed as income in the hands of the dependant(s).
- Income can be varied within allowable limits (see below) which gives flexibility. This can be useful for tax planning or where other sources of income are available.
How it works
Your current pension fund is either converted into Drawdown Pension, or more usually, you transfer into a new Drawdown Pension plan. You decide, up to the maximum available, what amount of tax-free cash you want (known as the Pension Commencement Lump Sum) and this is paid to you straightaway. If you do not want the full amount of tax free lump sum, you should consider a Phased Retirement plan. The maximum tax free cash sum that you can take is normally 25% of the value of your pension funds.
The remainder of your fund is invested for an indefinite time period (which could be until your death or until such time as you choose to purchase an annuity). From this fund, you may choose each year to withdraw income, the level of which is determined by whether you are eligible for ‘capped drawdown’ or ‘flexible drawdown’ (see below under ‘Income flexibility’). The income you draw will generally be taxed as earned income, with tax deducted at source.
The maximum amount of income that can be drawn is 150% of a comparable lifetime Annuity based on tables published by the Government Actuary’s Department. It is not however necessary for any income to be taken. Any amount of income from zero income through to the 150% maximum can be selected. The plan and maximum income will be reviewed every 3 years up to the anniversary of entering drawdown until the 75th birthday and annually thereafter.
Please note that these limits will be removed in April 2015 if the Government Proposal become legislation
If you have an income that meets the Minimum Income Requirement (MIR) of at least £12,000 per annum you will be able to draw down an unlimited amount from your drawdown pension funds and not be subject to the Capped Drawdown limits described above. The MIR is the same for all ages, applies to each individual and will include State Pension Benefits (both Basic and Additional), Final Salary Pensions, Lifetime Pension Annuities and Scheme Pensions. Types of income that will not count towards the MIR include Purchased Life Annuities, other State benefits and Drawdown Pension income.
To enter Flexible Drawdown you need to self-certify that you meet the MIR for the tax year in which Flexible Drawdown is applied for. Having entered Flexible Drawdown there will be no restriction on the income you are able to draw. While in Flexible Drawdown any further pension contributions will be subject to the annual allowance charge (this includes any further benefit accrual under a final salary pension scheme).
All income taken, whether under Capped or Flexible Drawdown, is taxable as earned income