Is income drawdown for you?

Published by Rachel Lacey on 04 June 2014.
Last updated on 30 November 2015

Pound coins falling

Instead of handing over your pension over to an insurance company in return for a fixed income for life, income drawdown allows you to leave your pot invested and cream an income off the top.

Under current rules you can draw down anything up to 150% of what you would have been able to get with the equivalent annuity with a capped income drawdown plan. To qualify for flexible drawdown - which doesn't have these restraints - you need to have a separate and reliable pension income stream of £12,000 a year.

April 2015 changes

However, from April 2015 these restrictions will be scrapped and all investors will be able to draw down as much or as little as they like. You can leave it all invested if you don't need the income, you can take off a monthly sum to live off, or save it for ad hoc lump sum withdrawals as and when you have big expenses to pay for.

Jonathan Lay-Watts, director of Wealth At Work says this flexibility allows investors to alter their income as and when their needs and spending changes – something you cannot do with an annuity. "Generally people have a ‘u shape' income requirement in retirement," he explains. "Initially they spend a lot, then it slows then in old age they need more care."

He adds: "People are so used to thinking an annuity is the only option, but they give no consideration to life stages. The product was designed at a time when life expectancy in retirement was just five or six years – the product hasn't changed but people's lives have."

The benefits of drawdown

The income drawdown route is expected to become increasingly popular following the announcements made in the April 2014 Budget and arrangements are already being provided at a low cost through online Sipp providers, which have sprung up to challenge the expensive offerings from more traditional pension providers.

The death benefits of income drawdown may also give it the edge over annuities.

Death benefits

In order, for annuities to provide a guaranteed income they need the money left over by those policyholders that died early into their contract to subsidise payments for those that live longer than the insurance company anticipated. This means that if you have a bog-standard annuity without any guarantees, any money that hasn't been paid out to you in payments goes straight back to the provider. So if you die early into your contract your family won't get any of your hard-earned cash.

Providers recognise that this isn't popular and so there is an option to select a payment guarantee of between five and 10 years - so if you died five years into a plan with a 10-year guarantee, payments would continue to be made to your family for a further five years. No remaining capital, however, would be returned.

By comparison, investors in income drawdown have more scope to leave any unused retirement savings for their partner or family. Beneficiaries can either maintain the plan, leaving the money invested and taking an income or they can convert it to an annuity. They can also take the money as a lump sum but it will be subject to death taxes (not inheritance tax, pensions are usually held outside of your estate) at a rate of 55%. This rate however is expected to fall to the beneficiary's marginal rate of income tax from April 2015.

So income drawdown offers you control over your money and flexibility as to how to take it. If you die it provides the peace of mind that your money can be passed on to your family.

Drawdown dangers

But however appealing income drawdown might seem, it's not for everyone. For starters it means you need to keep your money invested – choosing appropriate funds and keeping a tight watch on them to check performance doesn't go awry.

This is easily done if you can or are willing to pay for financial advice, but if you can't or won't you are going to have to commit time to both choosing and reviewing your portfolio, and if you don't fancy doing this when you are 60 or 65, there's a good chance you won't fancy doing it when you are 80 or 85 either.

Given the risks involved you also need to have a reasonable sized pension fund: you need to be able to absorb some losses here and there and have enough to generate a sufficient income without taking too high a risk with your capital.

How much money do I need?

Laith Khalaf, head of corporate research at Hargreaves Lansdown, says: "If this is going to be your only source of income you would want to have a fund worth at least £150,000, but if you had other sources of income you could do it with less."

So just because the restraints on how you generate an income retirement have been lifted, it doesn't necessarily follow that you should ditch the traditional route of an annuity that pays a guaranteed income for life.

However, if you have a larger pension fund, a higher tolerance for risk and feel that you need the flexibility to change the level of income you take from your fund, income drawdown might just be a better solution.

If you have both the confidence and the competence to select and monitor your investments it's cheap and easy to run your income drawdown plan from one of the many online Sipps.

Do you need advice?

However, given the amount of money at stake and the importance of making sure your money lasts as long as you do, it can make sense to shell out for some independent financial advice. In addition to helping you manage your pension, an adviser will also be able to help you through other financial challenges you might face in retirement such as paying for care as well as estate planning, which ensures that your money goes where you want it to when you die.

And, of course, you don't have to just go with income drawdown - in the new world it will be all the more easy to mix and match your options. Starting off in income drawdown before buying an annuity once you get older - and less healthy - or securing some fixed income with an annuity but giving a portion of your money some scope to grow in income drawdown. Striking this balance correctly might be difficult to do yourself - but it is an area where the advice of a good IFA can be worth its weight in gold.

How to run an income drawdown plan

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