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What is Flexible Drawdown?

Flexible drawdown allows those with secure incomes over £20,000 per year to take unlimited amounts of income from their pension funds, but this will be taxed at their marginal rate.  It is available for individuals aged 55 or over who meet the government's minimum income requirement (MIR).  The MIR is currently set at £20,000 per annum and the government has agreed this is the minimum guaranteed amount of income required by the individual. In essence, this process permits those individuals who feel they are adequately provided for by their pension schemes to withdraw any further pension funds, subject to them meeting the minimum level of guaranteed income.

Eligible individuals are able to withdraw, as and when, as much or as little money as they require, from their pension funds.  Withdrawals are treated as income for tax purposes and individuals should always assume that the withdrawal will be taxed at the basic rate of tax or higher.  This is because the individual concerned will always be in receipt of the income covered by the minimum income requirement and therefore, at minimum, they will be a basic rate tax payer from the onset.

Whilst flexible drawdown is available to any individual who meets the minimum income and age requirements, it may be of particular interest to higher rate tax payers who believe they will meet the MIR at retirement but will become basic rate tax payers later.  As it currently stands, these individuals would be able to withdraw surplus funds up to the higher rate tax bracket per annum and would therefore benefit from the differential between the two tax brackets; having paid into their pension as a higher rate tax payer whilst employed to then withdraw the money as a basic rate tax payer after retirement.

To avoid wide-spread abuse of this differential, the rules of flexible drawdown state that individuals who use this mechanism can no longer get tax relief on further pension contributions.

Meeting the Minimum Income Guarantee

Income sources eligible to form part of the minimum income guarantee include:

• State Pension Benefits - Basic and Additional
• Final Salary Pensions
• Pension Annuities
• Scheme Pensions

Purchased life annuities, protected rights funds, other state benefits and drawdown income do not count towards MIR.

Rules for Flexible Drawdown

The individual must meet the following criteria to be eligble for flexible drawdown:

• Have eligible sources of income to meet the minimum income guarantee [currently £20,000]
• No longer contribute (either in person or via a third party) to a defined contribution scheme.
• Not build up further benefits in a defined benefit (or cash balance) scheme.
• Must be 55 years of age or over.
• Provide a satisfactory declaration to the pension provider concerned that they meet the above conditions.

Drawdown

Like all drawdown plans, individuals who utilise flexible drawdown are also able to take 25% of the drawdown as a tax-free amount. In the event of death, your surviving spouse/dependants would have four options:

• Take the fund remaining on death as a cash lump sum less a one-off 55% tax charge; applicable to Non-Protected Rights element. Any Protected Rights element must be used to provide a spouse’s pension if married or in a civil partnership, otherwise it can be paid as a lump sum less the 55% tax charge.
• Use the fund remaining on death to purchase a lifetime annuity or,
• Continue in Income Drawdown, with the maximum income allowance based on their age and sex, or
• If applicable, defer the purchase of a lifetime annuity until they reach age 60.

No Inheritance Tax (IHT) will typically apply to lump sum death benefits either before or after age 75. Where there is no dependent it will be possible to pay the lump sum death benefit tax free to charity.

Advantages

• You are able to take all of your tax-free cash lump sum entitlement at outset.
• You do not receive a set income but are able to vary to suit your personal circumstances, up to a maximum limit (capped drawdown), to supplement other sources of income.
• You have the potential to benefit from good investment performance in a tax-efficient environment and to exercise control over your own investment portfolio.

Disadvantages

• High income withdrawals may not be sustainable during the deferral period.
• Taking withdrawals may erode the capital value of your fund, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income when an annuity is eventually purchased and could also affect the long term financial security of your spouse/partner.
• The investment returns may be less than shown in the illustrations.
• Annuity rates may be at a worse level when annuity purchase takes place. Although annuity rates generally increase with age, they have fallen dramatically during the past 15 years. This trend may continue.
• A careful investment portfolio needs to be constructed which will involve some investment risk. This means the fund value can fall which would affect your future income levels.
• Withdrawing too much income in the early years may have an adverse effect on preserving your pension purchasing power or preserving the capital value of your fund.
• Increased flexibility brings increased costs and the need to review arrangements on an ongoing basis.
• There is no guarantee that your future income will be as high as that offered by an annuity purchased today.
• The Financial Services Authority (FSA) has particular concerns in relation to mortality risk. If you purchase an annuity, you may benefit from a cross-subsidy from those annuitants who die early. This cross-subsidy is not present in drawdown contracts, so to provide a comparable income, a higher investment return will be required.
• The charges are ‘explicit’ whereas under an annuity they are inherent in the annuity rate offered.