Investing in a pension is generally regarded as a tax efficient method of saving for your retirement; until recently however, many people were put off due to the perceived lack of flexibility.
The new tax year heralded the introduction of Flexible Drawdown, designed to offer some pension savers greater access to their pension funds.
We thought we would take a look at Flexible Drawdown in more detail to see just how it works and who it might be suitable for.
What is it?
Flexible Drawdown is a new form of Income Drawdown which will allow certain individuals, who meet the Minimum Income Requirement (MIR), to take more income than is usually permitted.
If you meet the MIR you can take your whole fund in one go, although beware, the tax you would pay on such a transaction might make you think twice!
If you don’t meet the MIR, then you will only be able to use Capped Drawdown which is very similar to Income Drawdown people have been used to for years.
What is the Minimum Income Requirement (MIR)?
The MIR is the level of guaranteed income that you must have for you to qualify for Flexible Drawdown. It is designed to stop people taking all the money they have from their pension funds and then relying on the state for support.
The MIR is currently set at £20,000 per year, before tax. For income to be included in the MIR it must be guaranteed and therefore only certain sources of income will qualify, these are:
- State pensions
- Lifetime annuities, including with-profits or unit-linked annuities
- Scheme pensions from registered pension schemes
It should be noted that income from Purchased Life Annuities (PLAs) and Income drawdown contracts do not count towards the MIR. The exclusion of PLAs from the calculation is puzzling but nevertheless they do not count towards the MIR.
The Treasury will review the level of the MIR at least every five years, but an individual only needs to pass the test when they opt for Flexible Drawdown, they won’t be tested again if the MIR goes up.
Are there any other requirements?
Only two, firstly, you or your employer cannot have made a contribution to any pension in the tax year that you apply for Flexible Drawdown.
Secondly, the fund you use for Flexible Drawdown cannot include any Protected Rights funds; this is money which has been built up as a result of an individual contracting out of the State Second Pension or its predecessor, SERPS (State Earnings Related Pension).
How does it actually work?
In many ways Flexible Drawdown looks and feels like the Income Drawdown contracts we have been used to.
The usual tax-free lump sum is allowed, however providing you meet the MIR and have not made a pension contribution in the tax year you are applying for Flexible Drawdown there is no limit on the income you take.
Any income you do take will be added to your other income and subject to income tax at your highest rate.
It should be noted that if an individual becomes non-UK resident whilst in Flexible Drawdown, any income drawn when non-resident will be subject to UK tax if they return to the UK within five tax years of taking it.
Why might you want to take more income from your pension fund?
People have been calling for increased flexibility for some time, and Flexible Drawdown seems as though it may be the answer.
But just why would you want to take more income out of your pension fund than the maximum previously allowed? Surely this will deplete the fund over time thereby reducing the income you can take in future years? Whilst this is true, there are some circumstances when taking a greater level of income than the maximum could make sense, for example:
- You have income which meets the MIR, however this is insufficient for your current needs and you need to top it up perhaps in the short term until another source of income kicks in
- You need flexibility in the income level you can take and in some years will need more than the maximum amount allowed, for example to meet the costs of funding your children’s University education
- If you take money out of the pension under Flexible Drawdown it will be taxed at 20%, 40% or 50%, this compares to a tax charge of 55% on any lump sums payable on your death. If your estate is below the Inheritance Tax (IHT) nil rate band may be more tax efficient to take money from the pension, and pay the income tax rather than the 55% charge on death if your spouse or dependent takes the lump sum. Of course the 55% tax charge is not payable if your spouse or dependent does not take the lump sum and opts to take an income
Does every pension allow Flexible Drawdown?
Not every pension provider will offer Flexible Drawdown.
Some providers such as Talbot & Muir, Carey Pensions and Suffolk Life offer Flexible Drawdown already, others are still in the process of introducing it and other providers have said they will not offer Flexible Drawdown.
What are the drawbacks of Flexible Drawdown?
There are always drawbacks to any financial product, some specific to Flexible Drawdown include:
- If high levels of income are taken it is likely that the pension fund will be eroded over time, this may of course be acceptable to you, however it is a serious risk which you should plan for
- The charges for arranging a Flexible Drawdown plan may well be higher than for Capped Drawdown
- If you receive income from Flexible Drawdown and it is subsequently found that you were not eligible, penalties would be imposed
- Your pension fund will still be invested under Flexible Drawdown, you must ensure that any investments match your attitude to risk
- As soon as you enter Flexible Drawdown no further contributions can be made to your pension
If you think Flexible Drawdown might be appropriate for you it is vital you take independent financial advice, not only to confirm whether you qualify but also to confirm that it does indeed meet your needs.
Whilst there are advantages to Flexible Drawdown there are also many disadvantages which you need to fully understand before making the decision to proceed. You also need to find out whether your current pension provider is offering Flexible Drawdown and if they are not find an alternative provider who is.
Our advisers are of course here to help guide you through the complexity of Flexible Drawdown, feel free to contact us today on 0115 933 8433 or 0845 074 7778 to discuss your circumstances in more detail.