Your IndustryAug 25 2016

How flexi-access drawdown works

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How flexi-access drawdown works

For many years, clients have been able to choose between capped drawdown and flexible drawdown.

Capped drawdown had a set maximum on how much income can be drawn down while flexible drawdown had no limit on how much one could take from the fund as income, as long as the individual had a secured gross pension income of at least £12,000 a year.

But although flexible income drawdown was available before the then chancellor George Osborne announced pension freedom and the end of the requirement to buy an annuity since 6 April 2015, new rules also came into effect on that date, after which all new drawdown arrangements were classified as flexi-access.

This meant new rules applied to flexi-access drawdown products, necessitating a communications drive from advisers for both existing and potential clients.

As Greg Kingston, head of communications, product and insight at self-invested personal pension provider Suffolk Life comments, explaining what flexi-access drawdown is, and how it now works, can be difficult.

He says: “Although the public are coming to terms with what it means I imagine few understand the actual mechanics of how it works and is taxed.

We proposed describing drawdown as flexible income Rob Yuille

“If I were still an adviser now I’d be describing it as ‘saving for your pay in retirement’, as it is taxed more or less the same as a salary.

“You’re the boss of your own retirement and will be able to set your own wages, but you need to take care not to take out more than you can afford or you’ll go bust.”

How it works

Flexi-access drawdown is only available from money purchase - defined contribution (DC) - funds.

Any client with a defined benefit (DB) scheme requiring flexi-access drawdown would need to arrange a transfer out of their scheme - which requires a guide all to itself. Some of the issues with DB to DC transfers have been covered by AJ Bell’s Mike Morrison in a CPD article, which you can read by clicking here.

Also, if a client has funds in a DC arrangement which does not offer flexi-access drawdown, this might also require a transfer into a flexi-access drawdown arrangement with the same or another provider.

To confuse the issue, not all DC schemes offer flexi-access drawdown as it is not obligatory, so its availability will depend on a scheme’s rules.

Both the Pensions Advisory Service and the Money Advice Service offer plain English factsheets for potential clients seeking advice on drawdown.

But despite these technicalities, according to John Lawson, head of financial research for Aviva, the product itself is extremely simple.

He comments: “Flexi-access drawdown is, put simply, the most flexible way to draw down your pension once you reach age 55. It can also be a very tax-efficient way to pass money on to the next generation.

“It allows a pension saver to withdraw their tax-free lump sum, while the remaining 75 per cent can be left untouched, or withdrawn gradually over time as a regular income or as lump sums.”

Any remaining fund at death can be passed onto a spouse or any other beneficiary, who doesn’t need to be a family member.

A client can enter flexible drawdown earlier than 55 if they are in ill health (depending on the scheme provider).

They can take 25 per cent of the fund as a tax-free lump sum - although if they defer it, they might not be able to get this later on, and the 75 per cent remainder can be left invested, or withdrawn gradually over time as a regular income or in lump sums.

Flexi-access drawdown is, put simply, the most flexible way to draw down your pension once you reach age 55. John Lawson

Another flexibility means clients could move their DC pension pot gradually into income drawdown.

They could take up to a quarter of each amount moved from the pot tax-free and place the rest into income drawdown - although again, this depends on the client’s needs, the size of the pot, and whether they can afford it.

Anti-jargon

The Association of British Insurers (ABI) has been doing a lot of work on the ‘jargon’ element of flexi-access drawdown, highlighting how the new pension freedom and choice regime may have brought in too many new concepts without putting them into plain English.

Rob Yuille, ABI manager for retirement policy, says: “The ABI has been working with stakeholders to make the language used to describe retirement options simpler and consistent in order to help customers understand their retirement options.

“The industry understands that customers who are engaged in their pension are better able to make decisions that suit their individual circumstances so it’s important that we make these options as clear and comparable as possible.

“Based on consumer research and wider consultation, we proposed describing drawdown as flexible income - tax implications would be clearly explained upfront.”

Indeed, as David Trenner, technical director, Intelligent Pensions, comments: “Since drawdown was introduced in 1995, governments and civil servants have constantly changed the name to ensure the general public does not know what it is.

“Income drawdown became pension fund withdrawals, then drawdown became unsecured income, and then became flexi-access drawdown.

“You have to know the history of drawdown to know what is different about flexi-access drawdown.”

Regulatory concerns

The Financial Conduct Authority (FCA) is certainly concerned about the various ramifications of the whole pension freedom and choice regime, of which flexi-access drawdown is a key part.

In July this year, the regulator issued its terms of reference document, following its Retirement Outcomes Review. The document highlighted concerns about the numbers of customers entering drawdown products post-Freedoms without the use of a regulated adviser.

It found:

■ From October to December 2015, 32 per cent of reported drawdown sales were not associated with a regular adviser.

■ Over the same period, 29 per cent of pots were fully cashed out through flexi-access drawdown.

It also said: “Pension freedoms means there is no longer necessarily a one-off decision point, which could contribute to consumers disengaging and selecting the easiest option, for example, defaulting to a decumulation product with their current provider without properly considering the alternatives.”

The FCA intends to publish its final report in summer next year (2017).

Key changes to flexible drawdown
Before 6 April 2015 (flexible drawdown)After 6 April 2015 (flexi-access drawdown)
Flexible drawdown schemes/flexible income drawdownAll new drawdown arrangements classified as ‘flexi-access’.
No limit on how much can be taken as incomeClients can generally take 25 per cent as a tax-free lump sum at the outset
Individuals must have at least £12,000 a year in secured gross pension incomeRestriction no longer applies
Individuals wanting to make additional pension contributions had no annual allowance and suffered a tax charge on any contributions made. Taking income triggers the money purchase annual allowance - MPAA. Individuals can contribute up to £10,000 to their DC scheme without paying a tax charge.
Any money taken would be taxed as income in the usual way based on the individual’s tax band. If they took out too much, it could push them into a higher rate for tax purposes.Any money taken is taxed as income in the usual way based on the individual’s tax band. If they take out too much, it could push them into a higher rate for tax purposes.
Earliest one could take benefits (except for ill-health) was 55Earliest one can take benefits (except for ill-health) is 55

Mr Trenner adds: “Over a third of people are using flexi-access drawdown without advice, which is dangerous. There is already research by the Pension and Lifetime Savings Association which showed 53 per cent of people believed it would provide a guaranteed income, while one in four thought there were no risks with flexi-access drawdown.”

Suitability

Ultimately, suitability is key when it comes to recommending flexi-access drawdown.

Colin Simmons, retirement expert at Prudential, comments: “Since the introduction of pension freedoms, drawdown has increased in popularity. In fact, you might say Fad is indeed the current fad, but in this case, one that is likely to remain en vogue.

“The popular media has aided understanding of the concept of Fad, but there are complicated nuances regarding taxation and death benefits, and suitability very much depends on individual circumstances.”

Mr Simmons says, for example, someone with a pension pot of £250,000 may not be suitable for drawdown if it is all the money they have in the world.

He adds: “Much will depend on a client’s attitude to risk and capacity for loss.”

So while it is available to all, and potentially suitable for many, the long-term costs must always be weighed up.

As Aviva’s Mr Lawson says: “Flexi-access drawdown is suitable for everyone who would benefit from the advantages it offers.

“It is widely available, even to those with just £1 of savings.

“People who are risk averse or whose pension savings, together with other income, are only just sufficient to cover their fixed expenditure may be better to buy an annuity, as drawdown may present them with too much risk of not being able to pay for basic living expenses.”