Your IndustryJul 17 2014

Different drawdown options

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There are currently two drawdown options, ‘capped’ and ‘flexible’, which either cap the amount that can be drawn at a new, higher rate of 150 per cent of GAD rates, or enable your client to take as much as they like as long as they lock in a guaranteed income of £12,000 through other means.

Claire Trott, head of technical support at Talbot & Muir, says both capped and flexible drawdown can also be taken as a phased or partial drawdown. This is where only part of the scheme pays the pension commencement lump sum and income and the rest remains uncrystallised.

In addition, Ms Trott says it is not compulsory to take income from any drawdown product.

In terms of the pros and cons of the different options, Ms Trott says generally if there is no need to make pension contributions in the future and the client can meet the MIR, advisers will opt for flexible drawdown because it gives the greatest flexibility of income.

In addition, she says if it is possible to use partial or phased flexible drawdown it gives the greatest income options, but also protects the lump sum death benefits.

Ms Trott says: “This is because currently crystallised funds would be subject to a 55 per cent tax charge if paid out as a lump sum on death whereas the part that remains uncrystallised is paid out tax free.

“The 55 per cent charge is mentioned in the Budget proposals and is being reviewed, hopefully to be reduced in the future.”

To avoid the hefty tax charge on death, Stan Russell, pension expert at Prudential, says the spouse of a drawdown client can eschew the option of taking a lump sum and continue to draw down the income for the rest of their lives unchanged.

Mr Russell says that with capped drawdown, the new capping limit does mean a fund could run out in the event of poor investment returns. “Investment volatility and increasing longevity means it is possible for capital can be eroded too quickly,” he explains.

With flexible drawdown, Mr Russell says the fund could be treated like a bank account.

Mr Russell says taking too much income and paying a higher tax than necessary creates the risk of running out of money, although in this case the current £12,000 MIR gives a good safety net. This option does allow for estate planning flexibility, he adds.

For phased drawdown, Mr Russell says the customer enjoys greater tax efficiency due to income being part tax-free cash and part income.

Planning solutions

Stephen Lowe, group external affairs and customer insight director of Just Retirement, says the real appeal of drawdown is there is a broad range of plans that are as ‘hands on’ or ‘arms length’ as the client wishes.

Mr Lowe says this means drawdown can help professional advisers create bespoke financial planning solutions.

Mr Lowe says: “Drawdown allows the pension saver to be as adventurous or as conservative as they wish with the underlying assets while keeping them in the pension environment which gives tax advantages.

“Traditional income drawdown offers the possibility of growing the fund value or income flow over time, but against that is the possibility that taking too much from the fund or disappointing investment performance by the assets will erode the value or income.”

In the past, Mr Lowe says the success of income drawdown has depended to a large extent on good timing and many of those who went into drawdown before the credit crunch are likely to still be nursing hefty losses.

Traditional drawdown typically involves fees for advice, administering the pension and buying, selling and managing investments, Mr Lowe points out.

In recent years Mr Lowe says ‘guaranteed drawdown’ has become possible through products such as fixed-term annuities, which offer to pay a secure income for a set period of time and then return a guaranteed capital sum for reinvestment.

Fixed-term annuities should produce similar considerations for advisers to capped drawdown, agrees Mr Russell. He says with fixed-term annuities advisers should consider whether they offer appropriate death benefit options and also how attractive the real rate of return to the client is.

David Trenner, technical director of Intelligent Pensions, says he feels weighing up the various pros and cons phased drawdown strategies should be the standard for drawdown cases where retirees don’t need immediate access to their tax-free cash as they avoid paying income tax on withdrawals and on premature death.