Drawdown pension, also known as ‘capped drawdown’ is an alternative option to buying an annuity at retirement. Instead of purchasing a guaranteed income from an insurance company, pension savings remain invested and a percentage can be ‘drawn down’ each year.
An individual can choose how much of their pension pot they want to place in income drawdown (money not put into drawdown is protected from certain taxes on death). They can take up to 25% of the crystallised pension fund as a tax- free lump sum then continue to manage the remainder as an investment portfolio.
People who choose income drawdown will have a much higher degree of control and flexibility over their underlying pension fund income, timing of annuity purchase and death benefits. Because money remains invested, it has the potential to continue growing throughout retirement, unlike a typical annuity, where the value is fixed at the point the annuity is purchased. Drawdown is much more flexible than an annuity because a person can choose how much income they would like to take – subject to an upper limit. The maximum income is reviewed every three years until age 75 and annually thereafter. Income can be reduced or stopped if not needed. It is also possible to take one-off payments.
Any investor using income drawdown must have a clear picture of the nature of the risks involved, these include:
The periodic review process reduces the maximum income if the fund value is falling to prevent the fund from running out.
Currently, the maximum income a person in drawdown can take is 100% of a comparable annuity as set by the Government Actuary’s Department. Until April 2011, the upper drawdown limit had been 120% of a comparable annuity. The higher 120% limit is being reintroduced shortly.
The reduction in maximum drawdown income resulted in significant cuts to the maximum income of many thousands of pensioners, in some cases of up to 50%. Ever since the lower drawdown limit was introduced, the government has been lobbied by grassroots and industry campaigners such as AJ Bell for the 120% level to be restored.
The proposed date is currently March 26th. People going into drawdown from this date will have a 120% maximum. Those with a pension anniversary date on or after March 26th will be eligible for the 120% income limit from their anniversary date.
Someone already in drawdown or about to enter it would be able to receive a higher income than prior to March 26th 2013. For many drawdown investors this is welcome news. An investor currently in drawdown will be able to benefit from the new maximum limit from the next drawdown anniversary.
An investor aged 65, with a fund value of £200,000 would expect to have a maximum income of £11,600 pa under the 100% GAD rate calculation. When the 20% uplift comes into effect, the maximum income will increase to £13,920 pa.
In general, drawdown is considered less advisable for people with smaller pension funds. Any investor considering drawdown must fully appreciate the risks outlined above. You may also look to explore the income available from an annuity and understand the different types of annuity that are available. Drawdown is suitable for people who want more control and flexibility than they could get with an annuity.