At Retirement and the future
What to do with your pension at retirement
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There are many ways to explain,
yet it’s so easy to mis-understand
Pension Income Drawdown is the main alternative to purchasing an annuity. It can be more suitable once you have enough secure income to pay for your essential lifestyle needs.
Drawdown gives income flexibility and maximum control of your pension fund.
Examples of Pension Drawdown
Here are two graphics, the first explains the concept of drawdown, the second is an example. You might take all your tax-free cash, for good reason, but unless you need it, you don’t have to.
Your pension fund is referred to as the Accrual account because it contains a lifetime of accruals from your contributions. It remains an accrual fund until you draw income, when it normally becomes Flexi-access Drawdown. There some exceptions and you should take advice.
Before you take any income, each £1.00 in your pension is split - 75% taxable and 25% tax-free
Each £1 is treated separately. So to draw tax-free-cash, in this case 25p, you must move the whole £1 to a new drawdown account. As it’s moved, the 25p is split away to your bank account. There is no tax-free cash in this new account, so anything you draw is taxed as income. However your Accrual fund still has your tax-free cash intact.
Both the Accrual and Drawdown accounts maintain their tax efficient status.
£200,000 pension fund showing a single £10,000 (5%) tax-free cash withdrawal
This works just like the first £1 example, but with more money and without withdrawing all the tax-free cash.
If all the tax-free cash were taken, the accrual fund would be empty, although you can normally continue to pay money into that account and have 25% tax-free cash. * Subject to possible restrictions.
- You must move £40,000 to drawdown, in order to extract £10,000 tax-free. This tax-free cash is split away to your bank and the remaining £30,000 goes to your drawdown account.
- You can’t take the 25% out of your accrual pension without moving the other 75% to drawdown, because you can only take the tax-free cash from each £1.00 once.
* Your drawdown account it is subject to income tax once you draw income. Even the smallest withdrawal of income can seriously restricts tax relief on future pension contributions. Also bear in mind that legislation can quickly change.
It’s very important that you take independent financial advice before entering into drawdown.
You now have two accounts:
- Pension Accrual Account with £160,000, 25% of which (£40,000) is still tax-free.
- Income Drawdown Account of £30,000, which is taxable as income, but only on the money you withdraw. Both the drawdown and accrual money continue as tax efficient pension funds. You can withdraw money from your drawdown as regular income and it will be added to your other income for that year and taxed in the same way. Some providers allow single income payments and are more flexible, but how flexible your drawdown income is depends on your pension provider.
Phased income Drawdown
Phased Income Drawdown is the name for a gradual withdrawal of income and tax-free cash. For example you might reduce your working hours and make up the loss with drawdown income and when you fully retire increase it to what you need.
Specialist calculators will plan how many years your income can continue with this combination of tax-free cash and income. Financial advisers can do this, and some pension providers offer the facility. The money in both accounts is invested in the funds you choose, therefore the value of tax-free cash in your accrual fund will also change according to you pension fund’s growth.
Drawdown providers vary, some are restrictive with limited choice and others offer real flexibility.
There are benefits to not taking all your tax-free cash at once, for example allowing you to spread the tax benefit over future years and reduce your taxable income. In these years your income would be part taxable and part tax-free. Your provider might be able to offer this service, but you should check.
Assume your pension fund has grown from £160,000 to £180,000 and the remaining tax-free cash that was £40,000 is now £45,000. It’s still in your accrual pension you have an extra £5,000 tax-free cash.
- You can continue to take some or all of your tax-free cash without taking money from your drawdown account.
- You can choose to draw income as a combination of part tax-free cash and part taxable drawdown income, this can reduce your income tax in a year when you choose. In some instances it could help keep your income within your personal allowance, or below higher rate tax bands.
Since April 2015 pension drawdown has change to Flexi-Access Drawdown and it has added more flexibility, which surprised everyone at the time.
If you have a pension prior to this date and move, or have moved to drawdown, it will be called Capped Drawdown. This can offer advantages and also restrictions. If you are advised that you gain no advantage from retaining capped drawdown status, then you can normally switch to flexi-access drawdown.
Income drawdown is highly complex and requires financial advice, it’s too easy to make a mistake without it.
Planning your income withdrawal is a carefully prepared balancing act
Income Planner gives you peace of mind