An introduction to drawdown

Investors can choose how much of their pension pot they want to draw down, explains Billy Mackay, marketing director of AJ Bell, with the remainder of the funds being protected from certain taxes on death.

“They can take up to 25 per cent of the crystallised pension fund as a tax-free lump sum then continue to manage the remainder as an investment portfolio.”

Income drawdown is generally available from age 55, with exceptions for protected pension ages and ill-health.

One of the major attractions of drawdown is the death benefits, says Andrew Pennie, marketing director of Intelligent Pensions.

“A drawdown fund can continue to provide for a financial dependent and for lump sum death benefits; crystallised funds are taxed at 55 per cent and uncrystallised funds before age 75 can be returned without a tax charge.”

How much is drawn down is subject to limits set by the Government Actuaries Department (GAD) based on age, notes Alan Mellor, managing director at Phillip Bates & Co.

Mr Pennie says there is general discontent at the linking of drawdown to GAD rates, which themselves are based on (currently ultra-low) gilt yields. However, he notes that at the last Budget the government pledged to review this.

Most simply there are two types of drawdown: capped and flexible.

Capped is the most common form, with maximum income levels set every three years up to age 75 and annually thereafter. Maximum income levels have recently changed from 0-100 per cent of GAD back to the previous level of 0-120 per cent GAD.

Flexible drawdown, on the other hand, allows some investors, if they meet certain conditions, to draw funds from their pension without any annual limits.

It offers the flexibility to withdraw all of the funds from a pension in one go, draw a regular income above the capped drawdown limits to suit ongoing requirements, or draw additional funds to suit one-off circumstances.

The flexible drawdown option is only available if investors are able to meet a minimum income requirement with a secure retirement income of at least £20,000 per annum in the tax year of signing the declaration.

Income from state pensions, lifetime annuities, scheme pension and equivalent overseas pension payment equivalents all qualify for the MIR, but income from drawdown pensions and non-retirement incomes does not.

A restriction on flexible drawdown is that ongoing funding is not permitted. If a contribution is made to any pension scheme, or benefits are accrued in a final salary scheme significant tax charges may be incurred, says Mr Mackay.

“Flexible drawdown payments may be classified as ‘unauthorised’ and be subject to unauthorised payment charges if contributions are paid in the same tax year and if contributions are made once an investor has taken flexible drawdown, they will be subject to the annual allowance charge.”