Income Drawdown, which is also known as Capped Drawdown, has been around for many years. However, some people, particularly those with large alternative sources of income, found some aspects of Income Drawdown, particularly the annual income cap, too restrictive.
The introduction of Flexible Drawdown in 2011 was therefore designed to allow those people who qualify greater access to their pension fund as well as improved flexibility.
How it works – the basics
In many aspects Flexible Drawdown works in a very similar way to Income Drawdown:
- You cannot take any money from your pension until you are 55
- You can then take up to 25% of your pension fund as a tax-free lump sum
- The remaining pension fund remains invested in line with your requirements
- You can crystallise your pension fund in ‘slices’, taking only the tax-free lump sum and income you need. This leaves the balance uncrystallised and therefore available as a tax-free lump sum on death before 75
- You can decide at any point to move to an alternative retirement income option, such as an Annuity
- Your dependents have a variety of options on your death
However, the major difference between the two options is with Income Drawdown the maximum allowable annual income is capped. Whilst with Flexible Drawdown no such cap exists and those people who qualify can withdraw as much, or as little, as they like each year.
It is therefore possible to take the entire fund as a single lump sum, although there are potentially significant risks with doing so.
Whilst the tax-free lump sum is exactly that, tax free, any income taken from Flexible Drawdown is added to your existing sources of income and taxed accordingly.
Who qualifies for Flexible Drawdown?
Flexible Drawdown is only available to people aged 55 or over, who also satisfy the Minimum Income Requirement (MIR).
To meet the MIR a retiree has to have, in the tax-year in which Flexible Drawdown is entered, income of at least £20,000, before tax, from guaranteed sources, which are limited to:
- Lifetime Annuities, including Enhanced Annuities
- Investment Linked Annuities, providing the contract includes a guaranteed minimum income each year
- Pensions from Defined Benefit or Final Salary schemes
- State Pensions, including overseas equivalents
Income from the following sources cannot be used to meet the MIR:
- Income Drawdown plans
- Fixed Term Annuities
- Purchased Life Annuities
- Savings accounts
- Employment or self-employment
- State benefits, other than the State Pension
The purpose of the MIR is simply to stop people withdrawing all the cash from their pension, only then to fall back onto the state, due to a lack of income.
The MIR was set at £20,000 in April 2011. Although it does not increase each year in line with inflation, it is anticipated that the level will be reviewed every five years. An individual’s income though is only tested against the MIR once, when Flexible Drawdown is commenced.
There are a number of other criteria which must be met before Flexible Drawdown can be used:
- No pension contribution or accrual can have been made in the tax year in which Flexible Drawdown starts. Therefore, if you have made a pension contribution in the 2013/14 tax year, you cannot enter Flexible Drawdown until 6th April 2014 at the earliest
- Once you have entered Flexible Drawdown you or your employer cannot make any further pension contributions, including to work place pensions, without tax charges being levied
- Flexible Drawdown therefore should only be considered by people who are certain they no longer wish to contribute to pensions of any kind
What happens when I die?
Should you die whilst in Flexible Drawdown your dependents or beneficiaries have a number of options, which are the same as those available from Income Drawdown:
- Your surviving spouse, civil partner, partner or dependent can use 100% of the remaining fund to buy a Lifetime Annuity, or indeed select any other retirement income option, including an Enhanced Annuity, Fixed Term Annuity or Income Drawdown
- Your surviving spouse, civil partner, partner or dependent can take the remaining fund as a lump sum, although a tax charge of 55% will be payable
- Your surviving spouse, civil partner or partner can continue in Flexible Drawdown if they qualify and meet the MIR
To prevent the need to rush into a decision, your spouse or partner has up to two years to decide which option they wish to take.
If you have no spouse, civil partner or partner, but have children, they can also benefit from your remaining Flexible Drawdown fund.
As an alternative, where there are no surviving dependents, the entire fund could be left to charity, in which case no tax would be deducted.
Since it was introduced our Independent Financial Advisers have helped a wide range of retirees take advantage of Flexible Drawdown and have noticed that most people fit into three main groups:
Taking the entire pension fund as a single lump sum This option has mainly been used by people with relatively small pension funds, where taking an annual income is impractical due to the small income the fund would produce, or relatively high on-going product charges.
In these instances the maximum 25% of the fund has been taken as a tax-free lump sum. The balance of the fund has then been taken as income, subject of course to income tax at either 20%, 40% or 45%.
Withdrawing income up to the higher rate tax threshold In our experience retirees are generally unwilling to take large amounts of income from their Flexible Drawdown plan, which would then push them into higher rate tax. We are therefore seeing a trend of payments being taken, which when added to existing income sources, leaves the total taxable income just below the higher rate tax threshold.
This tactic has been used by retirees who are happy to ultimately withdraw their entire pension fund, safe in the knowledge that they have sufficient sources of income to meet their outgoings, from alternative pensions and investments.
Ad hoc withdrawals Finally, we have seen retirees who have no specific plans for the income they need, take ad hoc withdrawals as and when required.
These are just three examples of how we have seen Flexible Drawdown used, there are of course many other ways it can be useful to those people who qualify.
Advantages of Flexible Drawdown
- The tax free lump sum, of up to 25% of the fund, is immediately available
- You avoid the need to purchase a Lifetime Annuity, which may not currently be appealing
- You have complete flexibility in terms of the income you take and are not constrained by the maximum level available as you are with an Income Drawdown plan
- You can plan in advance, the level of income you wish to take each year and influence the level of tax you therefore pay. You do not have to receive a fixed income and are able to vary it to suit your needs
- Your pension fund remains invested in accordance with your wishes allowing for tax-efficient growth
- You need to crystallise less of your pension fund, than is the case with Capped Drawdown, to create the same amount of income. This allows you to leave larger amounts of your fund uncrystallised and therefore paid as a tax-free lump sum on your death before the age of 75
- You can choose to switch to an alternative retirement income option, for example an Annuity, should you wish to do so in the future
- The charges on a Flexible Drawdown plan are generally no higher than for Income Drawdown
- Your spouse, civil partner, partner, children or other beneficiaries have a variety of options on your death, which could provide an on-going income or lump sum, less tax, depending on their requirements
- The choices available on death are more flexible than most other retirement income options
Disadvantages of Flexible Drawdown
- If your completely deplete your Flexible Drawdown fund and your income requirements change in the future, you may face financial hardship
- Depending upon the investments you hold, the return you receive may be unknown and the fund value could fluctuate over time
- If the income taken, plus charges, is higher than the investment return the value of the Flexible Drawdown plan will fall
- The charges levied by Flexible Drawdown providers may be higher than those for other retirement income options
- Any lump sums paid out after your death, except those to charity, will incur a tax charge of 55%
Would you like to know more about how Flexible Drawdown can play a part in your retirement planning?
Our team of Independent Financial Advisers are here to help you, why not contact us today and learn more about whether Flexible Drawdown is right for you?
Call us today on 0115 933 8433 or email email@example.com