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Pros and cons of flexible drawdown

This article is part of
Guide to Flexible Drawdown

The greatest drawback with flexible drawdown compared with annuity purchase, is that if used incorrectly the funds can be quickly exhausted.

If the funds are exhausted your client could be left with no income for the later years, warns Tim Stock, technical consultant of Wesleyan Assurance Society.

Another big catch with flexible drawdown, according to Alastair Black, head of customer income solutions for Standard Life, is that not all individuals will qualify to use it.

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If your client is able to access flexible drawdown, Mr Black says you should also check if the provider levies additional charges for the service.

According to Mike Morrison, head of platform marketing of AJ Bell, the main advantages of flexible drawdown are:

• Individuals can take all of their tax-free cash lump sum, also known as the pension commencement lump sum, at outset

• As much or as little income can be taken as is required and all payments drawn are taxed under PAYE

• Individuals can draw specific amounts that allow them to make full use of their basic rate tax allowance

• As the pension fund remains invested there is the chance to benefit from investment growth in a tax-efficient way

• It is possible to leave as much of the fund as possible in a tax-efficient environment on death

The disadvantages, according to Mr Morrison, are:

• Longevity means resources in retirement will consequently need to last longer and flexible drawdown is an investment contract without certainty of return

• Withdrawing too much income in the early years may have an adverse effect on preserving pension purchasing power

• The MIR of £20,000 a year is a figure set by HM Treasury - in reality, the minimum income required by an individual in a year might be greater than this

• Increased flexibility brings increased costs and the need to review arrangements on an ongoing basis

• Future income levels will be dependent on investment returns and therefore an individual’s attitude to risk and capacity for loss must be taken into account

• If an individual were to die after age 75 without having taken the tax-free lump sum, lump sum death benefits would be subject to a tax charge of 55 per cent.

Standard Life’s Mr Black states, in light of the above, that if clients want to invest more money while they are in flexible drawdown, they would be better off looking at other tax efficient savings vehicles, such as stocks and shares Isas and international bonds.

He said: “Careful tax planning is required in order to maximise tax efficiency, particularly if making large withdrawals pushes your client into a higher rate tax band.

“Flexible drawdown isn’t for everyone, and it might not be appropriate for clients who need to crystallise more assets to meet the £20,000 minimum income requirement.”