Drawdown (Unsecured
Pensions)
Under the option of Personal Pension Fund Withdrawal (drawdown) you can
choose to immediately take a tax-free cash lump sum and then, instead of
buying an annuity, leave the remainder of the fund in a tax-efficient
environment.
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Drawdown Calculator
An annual income (taxed as earned income) can be taken from the invested
pension fund. This income may vary between limits, set at outset by the
Government Actuary's Department (GAD). The maximum limit is derived from
tables published by GAD and is based on your fund size, age, sex and the
current gilt yield. The minimum limit is nil and the maximum is 120% of
the GAD figure. The limits are revised every three years.
Tax Free Cash
Most types of pension plan have the option of taking a tax-free cash
lump sum before exchanging the residual fund for a series of payments.
Ordinarily up to 25% of the fund may be taken as tax-free cash., Income
A pension can be taken each year between nil and 120% of the maximum GAD
rate. This income is taxed as earned income under the PAYE system.
Death Benefits
If you die whilst in a drawdown contract your nominated survivor has
three different options open to them: -
- he or she can take the fund as a cash lump sum, free of
Inheritance tax on death before your 75th birthday, but the
remaining fund will be used in the Inheritance Tax calculation
should you die after age 75 (measures
are being introduced to raise this to age 77) or
-
he or she can buy an annuity with the fund.
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 it to suit
your personal circumstances, between set limits, to supplement other
sources of income.
-
You are able to mitigate your liability to personal income tax in
certain years.
-
You have the potential to benefit from good investment
performance in a tax-efficient environment and to exercise control
over your own investment portfolio.
-
It provides improved death benefits options compared with other
retirement products
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Drawdown Calculator
Disadvantages
-
High income withdrawals may not be sustainable during the
deferral period
-
Taking withdrawals may erode the capital value of the fund,
especially if investment returns are poor and a high level of income
is being taken. This could result in a lower income when the annuity
is eventually purchased and could also affect the long term
financial security of your spouse.
-
The investment returns may be less than those 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 could fall
which could affect your future income levels.
-
Withdrawing too much income in 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 on-going basis.
-
There is no guarantee that your future income will be as high as
that offered by an annuity purchased today.
-
You may feel the prospect of the future higher income does not
compensate for the known income available from an annuity now and
for the rest of your life.
-
You may be prevented from withdrawing your chosen level of income
due to the action of the GAD limits.
-
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 that die
relatively early. This cross subsidy is not present with Drawdown
and so to provide a comparable income, a higher investment return
will be required. The impact of mortality can be expressed as an
annual percentage rate by which the net investment performance of
the remaining personal pension fund would have to exceed the
interest rate implicit in an annuity in order to break even. This
effect has become known as the 'mortality drag'.
-
The charges are explicit whereas under an annuity they are
inherent in the annuity rate offered.
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Drawdown Calculator
Inheritance Tax Issues
If it is unclear that there were sound retirement planning reasons for
undertaking Pension Fund Withdrawal, and death occurs within two years,
the use of the contract may be deemed as an attempt to circumvent the
payment of inheritance tax (IHT). Furthermore, if you are in ill health
and decrease the level of withdrawals with the intention of keeping the
funds in your plan (thus outside of your estate), this may also be seen
as a deliberate attempt to avoid IHT. In both cases, the Capital Taxes
Office, could issue a claim and it is therefore vital that should your
circumstances or personal health alter, that you seek professional
advice on this very complex issue before reducing your withdrawals.
Critical Yield
Product providers using a common prescribed basis illustrate critical
yields. There are two types (A and B). Type A - the growth rate needed
on the "drawdown" investment sufficient to provide and maintain an
income equal to that obtainable under an equivalent immediate annuity.
Type B - the growth rates necessary to provide and maintain a selected
level of income.
Suitability
Pension Fund Withdrawal can be suitable for a whole range of differing
needs and financial situations, however it is generally accepted that
the potential disadvantages and the inherent risks involved require the
individual client to be a relatively sophisticated investor, who is
capable of fully understanding the risks.
Given this the contract can be used as a tax planning tool, a means to
accessing pension fund tax free cash without having to take the full
taxable income and as a means for offering greater death benefit
options.
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Drawdown Calculator
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