Flexible Drawdown was introduced in April 2011 and after a slow start seems to be gaining momentum, with more and more people taking advantage of the flexibility it offers certain people.
What is Flexible Drawdown ?
There are now two types of Income Drawdown, namely Capped Drawdown which looks and feels like Income Drawdown used to and Flexible Drawdown.
As the name suggest Capped Drawdown limits the amount of income you can take based on your age, sex and the GAD (Government Actuary Department) tables. As gilt yields have fallen recently so has the maximum amount which can be taken from Capped Drawdown, something we have written about extensively on our website.
Flexible Drawdown offers, for those people who qualify, unlimited access to their pension fund, without the upper limit of Capped Drawdown.
Who qualifies for Flexible Drawdown?
There are two main criteria.
Firstly you must satisfy the Minimum Income Requirement (MIR), which in simple terms means you must prove you have £20,000 gross per year from guaranteed sources. The only types of income which the Flexible Drawdown rules state are guaranteed are:
- The State Pension
- Lifetime Annuities (Purchased Life Annuities or PLAs do not count)
- Pensions from Defined Benefit or Final Salary Schemes
Secondly, you cannot have made a pension contribution in the tax year in which Flexible Drawdown starts, nor can you make any further pension contributions in the future
Lastly, Flexible Drawdown is not available on Protected Rights funds i.e. money built up from opting out of the State 2nd Pension or SERPS (State Earnings Related Pension). However, the distinction between Protected Rights and non-Protected Rights will be removed from the start of the new tax year, meaning all your pension fund can be used for Flexible Drawdown, providing of course you meet the first two criteria.
So, assuming you qualify, how are other people using Flexible Drawdown?
In our experience there are three main ways.
Drawing 100% of the fund
Some pension experts were worried that as soon as Flexible Drawdown was introduced those people who qualified would take all the money out of their fund; in our experience this has not been the case, in fact we have had no clients opt for this route.
It is likely that income tax rates of 40% and in some cases 50% are putting people off stripping their entire fund out in one transaction. Furthermore pensions, and in particular SIPPs are very flexible in what investments they will allow, meaning that many investment opportunities can be accommodated
Taking the maximum tax free lump sum and drawing income to the higher rate tax threshold
In our experience clients seem to be unhappy to pay 40% tax and are therefore taking additional income, above the £20,000 minimum they already have, but turning the ‘income tap’ off before they reach they reach the higher rate tax threshold.
We are also finding that most people in this group take the maximum possible tax free lump sum, 25% of the fund.
The additional income seems to be used for funding a better lifestyle rather than meeting the costs of day to day living.
Phased Flexible Drawdown
Our experience tells us this is the most popular option and is used by people not wanting to immediately take 100% of their tax free lump sum and who require ultimate investment flexibility.
One of the issues with putting all their fund into Flexible Drawdown is that on death any lump sum paid is taxed at 55%, whereas it is not subject to tax before the age of 75 if no benefits have been taken.
Those people who like the idea of Flexible Drawdown, but who do not need immediately need the full tax free lump sum should also therefore consider Phased Flexible Drawdown.
Our experience shows us that people in this group will identify their income requirement year on year, generally to a level so they don’t pay higher rate tax, and then crystallise the amount they need.25% of which will be tax free lump sum, with the balance as a taxable income,usually paid in the form of a lump sum rather than monthly income payment.
The main benefit of method is that the balance of the fund, which has not been crystallised, is available as a tax free lump sum on death before age 75, whereas if the whole fund had been crystallised the fund would be subject to a tax charge of 55% in the event that a lump sum was paid.
If you satisfy the Minimum Income Requirement, or are close to the required level then Flexible Drawdown could have a part to play in your retirement income strategy.
There are of course other considerations to bear in mind when looking at Flexible Drawdown, for example should you use a SIPP or a Personal Pension and how the funds are invested; we will look at these next month.
Our SIPP team are experienced in handling this type of transaction and are here to help, guide and advise you through to the right decision.