MANY people are not aware that the rules on pensions changed on the 6 April 2011.
For some people there is now a greater flexibility on how they can access their pension fund.
Income drawdown has been around for a number of years. However, there are now two different types of drawdown.
Capped drawdown is the traditional method of income drawdown and allows an income to be drawn directly from the fund, subject to a government-set maximum. The investor can choose any level of income up to the maximum and vary it each year if required. The income limit is reassessed every three years.
Last year saw the introduction of flexible drawdown. This grants investors the opportunity to withdraw as little or as much income from their pension pot as they wish, without reference to the limits under capped drawdown, if they can meet certain conditions. It is even possible to withdraw the whole fund.
Previously, pensions may not have been ideal for some investors because they saw them as a restrictive method of savings, with limitations on how the income could be withdrawn at retirement.
Flexible drawdown helps to overcome some of the limitations, although it will typically only be available to those investors with larger pension pots.
To qualify for flexible drawdown, a minimum pension income of £20,000 per annum must be secured already, to prevent money running out later in retirement.
Income that qualifies towards the minimum income requirement includes: income from a lifetime annuity from a registered pension scheme; income from a registered pension scheme, if the arrangement has 20 or more members entitled to the scheme pension; income from the state pension.
Flexible drawdown will be subject to income tax in the same way as other pension income and taxed through PAYE.
For example, consider an investor who has secure pension income of greater than £20,000 from her state pension and a final salary scheme. If she also has a personal pension worth £200,000 she could elect to use flexible drawdown. She would be entitled to take 25 per cent of the fund as a pension commencement lump sum (or tax-free cash as it is commonly known). The balance of £150,000 could be withdrawn as the investor wishes, subject to income tax. It would be possible to withdraw the whole fund at once; however, in this example, it would put the investor into the 50 per cent tax bracket in the current year. It may be more prudent to draw an income that would keep her within the basic tax rate. A competent adviser could assist with this.
Income drawdown can be continued to any age and the income drawdown fund can be converted to an annuity at any point if the investor wishes.
There are other factors that should be considered, such as the death benefits while in income drawdown and the investor’s attitude to risk prior to entering income drawdown.
While it is not for everyone, flexible drawdown is a popular option for those who meet the minimum income requirement because it avoids passing the fund to an annuity provider and hoping that they survive long enough to get a decent return.
• Grant Walker is a director at Edinburgh Risk Management
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