PensionsMar 17 2014

Is there still a market for ‘limited’ flexible drawdown?

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

Given the nature of complaints relating to how much income can be secured through most products due to longevity, low gilt rates and persistently low interest rates, flexible drawdown in particular should be attracting more attention.

The option was first announced by the new coalition government in 2010 as part of a range of changes to do away with secured pensions and the effective compulsion to annuitise.

As the name suggests, flexible drawdown is free of the tie to annuities and therefore gilts longevity trends. There are, in fact, no income limits at all, meaning retirees can draw as much income as they like and can even draw their whole pot.

The caveat: retirees must be able to prove they have a minimum income of £20,000 a year, which has to be guaranteed and likely places the individual back into what is likely to be an expensive annuity.

The risk: the pension remains invested, meaning where the whole fund is not withdrawn it is subject to market fluctuations and can therefore rise or fall depending on investment performance.

So what’s the appeal?

Carl Lamb, chief executive of IFA Almary Green, says: “The advantage is that if you are fortunate enough to have that guaranteed level of income then the legislation gives you a greater level of freedom and choice of how and when you draw your income from the fund.”

Clare Bruce, a chartered financial planner at Guardian Wealth Management, says it provides a “great advantage” to early retirees who wish to use their pension money to fund a lifestyle “in the early years”, when GAD and annuity rates can be lower than expectations.

She adds it can be used as a form of tax planning by taking the whole pot: putting crystallised pension funds, which would ordinarily be taxed at 55 per cent on death, back into that individual’s estate.

According to Adam Wrench, head of business and product development at London & Colonial, flexible drawdown will only be attractive to wealthy retirees, who have other sources of retirement income available and be in possession of sufficient assets to make inheritance tax liability a “major concern”.

Indeed, data published by the Pensions Policy Institute revealed that in 2010, 200,000 people - or 2 per cent of people aged 55 to 75 - were able to use flexible drawdown. A further 500,000 people may be able to use it when they reach their state pension age.

Why so little uptake?

Flexible drawdown is not offered by all providers, probably due to the limited market because of the minimum income requirement.

Mr Lamb says the MIR is typically formed of a combination of state and occupational pensions - and often lifetime annuities - and excludes all other forms of income such as investment and rental income.

This, as mentioned above, limits the income option to the wealthiest group of savers.

Mike Morrison, head of platform marketing at AJ Bell, says: “The MIR has been set a level that is too high for it to be attainable for significant numbers of people, one of the key reasons why we’ve been calling for flexible drawdown reform.”

Also, taking significant amounts of money from a pension is not going to be the right answer for everyone. As those in flexible drawdown can draw down the whole fund, Mr Wrench warns this could lead to fund depletion as well as future income reduction.

He says: “There is also an ongoing risk of the residual fund compared with annuity purchase.”

Mr Morrison adds flexible drawdown removes savings from an environment where “they are free of capital gains tax, investment income tax and inheritance tax”.

Indeed, Ms Bruce says that without careful planning, “a client could find themselves with a very high income tax bill”.

She also warns that once under a flexible drawdown agreement, clients may not make any further pension contributions or be a member of any occupational pension schemes.

Ms Bruce says: “This could be of particular concern for an individual continuing in employment as now automatic enrolment could cause issues.”

Has it failed?

Citing the PPI figures, Mr Morrison believes flexible drawdown has “failed” and has fallen well short of government’s estimates.

He says: “It hasn’t helped that some providers were slow to offer flexible drawdown, perhaps fearing it would lead to large sums being withdrawn. In reality, with withdrawals mainly made with tax planning in mind, their fears have proven unfounded.”

Despite the disadvantages, Ms Bruce believes that flexible drawdown has done “fairly well” since its inception, adding that clients using this have “benefited greatly”.

Ms Bruce says: “In my experience, those who benefit the most are those with very proactive and experienced advisers. Typically clients are unaware of the rules and so, unless they seek advice, they wouldn’t know it exists.

“It is an important benefit for high net worth clients and an excellent advice-point for planners.”

However, Mr Wrench believes that the government’s continuing reduction to the amount of income that can be taken each year means that flexible drawdown is becoming “increasingly popular” and the “better option” if you can afford it.

Due to the high MIR, flexible drawdown would appeal to those with final salary plans as well as additional private arrangements, Ms Bruce adds.

She says: “Securing £20,000 via an annuity from private funds can be expensive, so unless a client already has some structured income in place then they may not be keen to spend a huge amount of their funds to get it.”

More flexibility needed

Despite the advantages and disadvantages of flexible drawdown, Ms Bruce and Mr Wrench both believe that this sort of flexibility in pensions is exactly what the market needs.

Ms Bruce says: “Clients, particularly high-earning individuals who should be saving significant amounts for retirement, are too quick to avoid pension savings due to their reputation for being restricted.

“Now pension legislation is adapting to demand, it should further encourage individuals to properly save for retirement.”

As it does have a limited place in the market and only appeals to the wealthier section of society, “it will be interesting to monitor future trends”, Mr Wrench adds.

He says: “The minimum income requirement is not currently linked to inflation but it will be interesting to see whether its appeal widens as inflation could increase the potential market for drawdown.”

Mr Morrison wants to see more steps taken to make the retirement product more accessible. AJ Bell has suggested introducing a “straightforward, more accessible requirement, enabling savers to withdraw 10 per cent per annum of any pension savings in excess of £200,000, irrespective of their age”.

He says: “It was a radical step for the Treasury to say that there is a level of income that you must provide to prevent you from falling back onto State benefits and if you wish to spend the rest of your fund then you can.

“As providers come into the market, the awareness of flexible drawdown will go up and the ongoing concern with annuities will also add to the demand.”

Update, in this year’s Budget, changes were made to the minimum income for flexible drawdown and general rules.