Take an income and give your pension the potential to grow
Income drawdown lets you to take your retirement income directly from your pension fund, the rest of your pension fund still has the potential further growth.
On our website you can find out how income drawdown can be your preferential choice for retirement income.
Many retirees wrongly think that they have to purchase their retirement income from the pension provider they saved with. Taking income drawdown advice can give you the flexibility you need in retirement.
As you approach retirement, you will have to decide how best to use your pension fund for the years ahead. One of the ways of doing this is by entering drawdown. This guide will explain what drawdown is, some of its important attributes and the potential risks involved.
Before reading this guide, we recommend that you make sure you understand the range of options available to you at retirement by reading our planning for retirement guide.
What is SIPP Income drawdown?
Drawdown is a way of taking an income from your pension fund once you are old enough without buying an annuity. You retain control of your pension fund and therefore your investments.
Drawdown gives you flexibility over the amount of income you take from your pension fund and the frequency with which you take it. What’s more, you are able to vary the frequency and amount taken.
Drawdown thus places considerable responsibilities on you and has significant risks. It’s generally only available via a financial adviser and we would highly recommend this route.
SIPP Income Drawdown rules
- You must be at least 55 year old in order to start drawdown.
- You do not have to stop work to start drawdown.
- You do not have to put your entire pension fund into drawdown at once.
- You can split your pension fund between buying an annuity and entering drawdown.
- If you choose drawdown, you can still purchase an annuity later on.
- You can continue in drawdown as long as you wish – you do not have to buy an annuity.
- Drawdown is a common feature offered by many self invested personal pensions and insurers.
- When you put part of or your entire pension fund into drawdown, you will be entitled to a tax-free lump sum. This is called the pension commencement lump sum (PCLS) and is normally 25% of the value put into drawdown.
- You can draw an income from the remaining 75% of the funds – this income is taxed at your marginal rate.
- The choice of allowable investments is likely to remain the same, although some may not be suitable for drawdown (for example, they may be too volatile).
- There are special rules on what happens to your fund if you die.
Capped drawdown places a limit on the amount of income you can withdraw from your fund each year. Before age 75, the limits apply for 3 years and are then recalculated. At age 75 the limits are reset and then recalculated every year thereafter.
The maximum income is based on your fund value and something called the GAD factor, so called after the table set down by the Government Actuary’s Department (GAD). It determines how much money per £1,000 in your fund you can withdraw. It is based on your age, sex and government bond yields.
Each time the income withdrawal limits on capped drawdown are recalculated, they may go up or down. There is no restriction on how much the limits may change.
Flexible drawdown is a special form of drawdown under which any amount of money can be withdrawn from the pension fund. There are 2 requirements you have to meet before undertaking this option: you must meet the minimum income requirement (MIR) and you must have stopped contributing to any pensions.
The MIR is set at £20,000 per annum and only certain income sources can be counted towards it, including your state pension and certain company pensions and annuities. Your financial adviser can give more information about flexible drawdown.
Attractions of SIPP Income drawdown
Drawdown can be helpful for tax planning. For instance, if you still work and your income fluctuates, you can vary your level of income from drawdown to smooth this out. In good years you may be able to reduce or even cease drawing down an income, avoiding paying additional income tax.
Drawdown allows you to continue investing and seek growth. If you are successful in this, you will be able to keep pace with or exceed inflation.
If your investments grow, you may be able to withdraw a higher income in the future or pass on a higher fund value in the event of your death.
Drawdown can be helpful for estate planning (passing on an inheritance). For instance, by phasing drawdown, you can potentially reduce your exposure to inheritance tax in the event of your death before reaching 75 years of age.
Drawdown allows you to make changes as your circumstances change.
What happens if I die?
The options will depend on whether you have a spouse or registered civil partner and/or financially dependent children. If so, they will be able to choose from the following 3 options:
- Continue the drawdown – in which case they will be able to draw a taxable income from the fund. They should ensure they are willing, and have the capacity, to take on the risks of drawdown. In the case of children, they will normally only be able to continue drawdown up to 23 years of age; there are special withdrawal limits that enable them to exhaust the fund by then.
- Buy an annuity – please see our annuities guide for more information on annuities work.
- Take the fund as a taxed lump sum – the fund will be paid out as a lump sum death benefit. For funds in drawdown, there is a tax charge (currently 55%). See our inheritance tax guide for more information.
If you do not have any financial dependants, you can leave the remaining fund as a taxed lump sum (option 3, above) to beneficiaries of your choice, or you can leave it tax-free to a registered charity.
Risks of drawdown
- The value of the investments in your pension fund can go down as well as up.
- Early investment losses can be particularly difficult or even impossible to recover.
- If your investments fall in value, you may need to reduce the amount of income you withdraw from your fund.
- If your investments fall in value, or fail to grow sufficiently, you may not be able to withdraw as much income in future.
- For capped drawdown – as you get older, the GAD factors increase, allowing you to withdraw money from your fund faster. However, your income withdrawal limits can still fall if your fund value has fallen (or not grown enough) and if government bond yields have fallen.
- If you postpone buying an annuity by choosing flexible or capped drawdown now, you may find that annuity rates are worse in the future.
- You may be able to achieve a higher income from an enhanced annuity
- Take financial advice: this is a very important and complex decision and your pension fund will be one of your largest financial assets.
- Continue to take advice. Drawdown is not a one-off event: your investments need continual monitoring and you will need to make adjustments depending on investment performance and your individual circumstances.
- If you want complete control over your fund, then you need flexible drawdown – which means securing an income of £20,000 per year.
- Drawdown does not provide certainty – if you need certainty, drawdown is probably not for you.