Information about Income Drawdown and how it works
What is Income Drawdown?
Income drawdown is a means to take money from your pension fund. You can take up to 25% as a cash free lump sum from the total value of the pension pot. The remaining 75% remains invested.
Most clients draw an income from the remaining investment, this is amount is dependent on your age and what is commonly known as GAD rates. GAD is an acronym for Government Actuarial Department. The percentage figure determined the GAD rate is dependent on Gilt yields. HM Treasury issues gilts which are simply liabilities in sterling to offer security on investment. The British government has never failed to make interest payments on gilts as they fall due.
The orange slice is your tax free lump sum (upto 25%). The remaining green pie remains invested in the fund and can have an annual income drawn from it.
So what is the GAD?
The 15th of each month is an important date, this is the announcement date for the next monthly rate (rates applied from the 1st until the last day of the following month)
GAD rates are critical- the rate value determines the income a person is allowed to take from an income drawdown contract. Over recent years the GAD rates have declined, this drop bears reflection to the general downward course of annuity rates. The bottom line is that this restricts income to be taken from the income drawdown contract
GAD Review Date
It is not permissible for a person to change income received on a monthly basis. There is a system in place which currently calls for a review on a tri-annual (3 year) basis. Some investors with older income drawdown plans may be approaching their GAD review date after 5 years (once their next review has been completed it will only be a 3 year duration.)
In October 2007 the GAD was 4.75%, back then it was possible for an investor to have taken a maximum allowable income equating to 120% of GAD. The current roles limit the Max GAD to 100% and with GAD rates residing at 2.0% (April 2015), this denotes a significant drop income.
Income flexibility and investment choice
So you’re aware that the income you take is limited by the GAD rate. With income drawdown you have the option to alter the income taken, stop taking it altogether, invest in a new scheme to yield another pension income.
There are numerous funds with opportunities to invest such as:
- INDIVIDUAL SHARES
- FIXED INTEREST
- GLOBAL EQUITY FUNDS
- MANAGED FUNDS
- PROPERTY FUNDS
- COMMERCIAL PROPERTY
Some investments come with a higher risk and tend to produce returns to cover income withdrawals, with possible allowances for capital growth. During periods of market volatility these higher risk funds can experience greater losses; this could lead to a negative effect on the base capital.
Low risk investments are unlikely to replace the returns that would lead to a successful replacement of the income taken, specifically if the maximum lump sum is taken.
Death benefits of Income Drawdown
As of April 2015 new rules have come into action which affect the passing on of drawdown pensions to any named beneficiary on death.
If the scheme holder dies before their 75th birthday, the remaining pension fund can be passed on entirely tax free. Investors who die beyond 75, the recipients of the income will pay their marginal rate of tax on the income they take from it. Inheritance tax is no longer payable and is regardless of the size of the pension fund. There is one exception to this, if a PPS (personal pension plan) has been vested (crystallised), to provide benefits (allowable from the age of 55), there may be some inheritance tax to pay.
Some investors may choose not to have the tax free lump sum, instead they can opt for a choice known as phased drawdown. This works by allocating part of the income they received from the pension plan allocated to the tax free element. The part forms the rest of the funds, essentially this means that 1 quarter is kept free from income tax.
Budget 2014 Changes
In the budget of March 2014 it was announced that from April 2015 there will be no restrictions on the income allowance from a pension. Essentially a retied person could take any income between zero and the full fund value.
An income drawdown investor has the option to change the income they are taking, cease income activity or invest in a new scheme to produce a pension income such as annuities.
Income drawdown is highly popular and yet not always a suitable option for everyone. In comparison to an annuity there is no guarantee that an income will be paid for life.
Withdrawals can reduce the pension fund and the annuity rates may decline in the future, which would most likely lead to a reduced level or loss of retirement income.
Purchasing an annuity attracts smaller charges than investing in an income drawdown contract. The simple reason for this is that income drawdown is subject to regular assessment to determine the strength of the plan and to call in to review options available to the investor; the higher charges are reflected in this.
Getting financial advice
While the information here and information available from other sources may be very helpful, no one should ever make significant changes to their investments without the advice of a qualified financial . This is crucial and can make the difference between slight financial issues to a full financial ruin in the investment area. Pensions are meant to serve a purpose later in life and while there are always needs that are more current, retirement without income can be very difficult.
Choices for the future can be made easier with the advice from those that are qualified with the use of an investor’s ATR or Attitude to Investment Risk.
Want more information?
Retirement options should never be decided on a whim, they deserve careful consideration. We believe that all our customers should receive the same service and options that we ourselves want in our retirement. If you’re unsure about what is right for you, or you simply want further information to help you make the right decision please talk to us.