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All new pension drawdown plans are set up ‘flexi-access drawdown’ rules where there are no income limits.
Before 6 April 2015, drawdown plans were set up under ‘capped drawdown rules’ which restricted the maximum income to 150% of the GAD income factor. There may be some technical reasons why individuals may wish to continue with capped drawdown. For example, providing the 150% of GAD income is not exceeded, capped drawdown investors are not subject to the new Money Purchase Annual Allowance (see below).
There are no minimum or maximum income limits which means that up to 100% of the fund can be taken as an income payment and income payments can normally be taken at any time.
In practice, most people will either make regular income withdrawals to provide retirement income or a take series of ad hoc income payments to supplement their other retirement income in a tax efficient manner.
When regular income payments are taken, it is important to consider the ‘sustainable level’ of income (see below) and when ad-hoc payments are made it is especially important to be aware of the tax consequences.
All income payments will be taxed at the recipient’s marginal rate of tax. Higher rate tax payers may be able to reduce their tax planning by spreading or phasing income payments if they will be basic rate tax payers in future years.
A drawdown pension plan can be invested in a wide range of things including:
- Cash accounts with banks and building societies
- Pension funds from insurance companies
- Unit trusts and onshore and offshore open ended investment companies (OEICs)
- Investment trusts
- Individual stocks and shares quoted on a recognised UK or overseas stock exchange Commercial property
Typically, a drawdown plan will be invested in some of the above investments in one of following ways:
- Through an insurance or investment company
- On a platform arranged through an adviser
- Self-select (no-advice)
- Self-invested personal pension (SIPP) through an adviser
Investing in drawdown is very different from investing before retirement and therefore it is advisable to take professional advice, not only on the initial investment strategy but in order to have regular financial reviews to make sure the plan is on target.
Most drawdown plans offer three options following the death of the plan holder:
- Pay the balance of the drawdown pot as a cash lump sum
- Arrange flexi-access drawdown for beneficiaries (no income needs to be taken)
- Purchase an annuity for selected beneficiaries, normally a spouse / partner
If the plan holder dies before age 75, all payments (cash or income) will be tax free, but if death occurs after age 75, any cash or income will be taxed at the marginal rate of tax payable by the beneficiary.
There are three types of beneficiary; a dependant, a nominee and a successor. A dependant is a spouse, civil partner, child under the age of 23 or someone who was financially dependent on the plan holder. A nominee is anyone nominated by the member and a successor is anyone nominated by one of the beneficiaries. In short, almost anybody can be nominated to be a beneficiary of a pension pot.
Although many people may choose to nominate their spouse or partner as a beneficiary, it is possible to nominate children or other family members or friends as beneficiaries and so the pension fund can be handed from one generation to another.
Watch out for
There is a lot to watch out for but by far the two most important things to keep an eagle eye on are the amount of income you take out and where your drawdown is invested.
These two things are intricately linked because of the sequence of return risks. Investing when you are taking income withdrawals is different to investing without taking income and this is because if the returns are low or negative in the early years you will erode your capital fast and it will be hard to recover from early losses.
When you take income from a flexi-access drawdown it will be a trigger event for the Money Purchase Annual Allowance (MPAA).
Although drawdown may seem easy to understand the risks are much harder to understand, especially if compared to the guaranteed income from an annuity.
If you want to make the most of pension freedoms you should start planning ahead and make sure your financial affairs are in good shape in the years running up to retirement.William Burrows
Call: 07730 435 657
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