This Q&A document should be read in conjunction with the Key Features Document (KFD) relevant to the provider of your flexi-access drawdown, their quotation and any other documentation they refer to. Any references we make to taxation are based on our understanding of current legislation and HM Revenue & Customs practice which can change.
Q1. What is flexi-access drawdown (FAD)?
Flexi-access drawdown is a form of personal pension that enables you to take an income directly from your pension fund, keeping it invested, without having to buy an annuity, hence you retain control of your pension fund and therefore your investments.
You are able to take 25% as tax free cash, with the balance being treated as taxable income. You can take regular income or irregular income from your fund and even postpone your income should you wish. In the event of your death, it also gives you the ability to pass on your fund to your spouse, the next generation or to whoever you want, tax free before age 75. On death after 75, the lump sum or income is taxed at your beneficiaries' marginal rate.
This option can be useful if you want to keep your options open for the future, especially if you anticipate a change in your circumstances.
Q2. How does it differ from other options?
A standard conventional or enhanced annuity provides guaranteed payments for life, no matter how long that is. So your future annuity payments are known in advance. However, once set up, the payment terms cannot be altered, even if your circumstances change.
Flexi-access drawdown offers you more flexibility without committing to a life time annuity. However, you need to be satisfied with ongoing investment risk, in that the value of your fund and therefore your income, may go down depending on the performance of the underlying investment. This option however, offers greater death benefits than a standard conventional or enhanced annuity.
A fixed term annuity is written under the same Drawdown rules as flexi-access drawdown to provide a regular level of income for a specified time period e.g. five years. At the end of the specified term, a guaranteed maturity amount is paid for you to reinvest in an annuity or another retirement product available at that time or to take as a lump sum, subject to income tax.
Flexi-access drawdown is more flexible than a fixed term annuity as you have the ability to vary your income. It also offers the potential for your fund to benefit from investment growth, which is not available through the fixed term annuity.
Uncrystallised Fund Pension Lump Sum (UFPLS) enables you to take your pot as a cash lump sum. You can normally take 25% as tax free cash, with the balance subject to tax at your marginal rate. Alternatively, you can take a series of lump sums, 25% of the amount paid is tax free, with the balance taxable as pension income. Please note that this option can result in you paying higher rate tax.
Flexi-access drawdown differs from UFPLS, which is normally only available through your current provider, in that you have the flexibility of taking your tax free lump sum and being able to leave the balance invested, to provide an income and to pass on to your loved ones in the event of your death.
Q3. How much income can I take from this plan?
Under the new pension rules there is no restriction on the level of income that you are able to take, however, you should be mindful that taking a high level of income may result in your fund being depleted and not lasting for the rest of your life. If you are using FAD to defer buying an annuity, as your plan is dependent upon investment performance and future annuity rates are unknown, it could result in you obtaining a lower income than if you had purchased an annuity at outset.
The predecessor to flexi-access drawdown, called flexible drawdown, had a minimum income requirement of other secured income (state pension and other pensions in payment) of £12,000pa. Because of the potential uncertainty of your income from flexi-access drawdown, you may want to consider securing income from a conventional or enhanced annuity first, before investing any remaining balance in FAD. The Joseph Rowntree Foundation suggests that people should have at least £13,500 pa of guaranteed annual income before considering investing into unsecured income options, like FAD.
Q4. Do I have to take an income from my plan?
No. You don’t have to take an income if you don’t want to. So if you only want access to the tax free cash, this is possible. The balance will then be invested in one or more of the funds that are offered to you that are commensurate with your attitude to risk.
Q5. Under the new pension rules, can I take all my money out in cash?
Under the new rules there is a new option called uncrystallised funds pension lump sum (UFPLS), whereby you are entitled to take your pot as a cash lump sum. You can normally take 25% as tax free cash, with the balance subject to tax at your marginal rate. Alternatively, you can take a series of lump sums, 25% of the amount paid is tax free, with the balance taxable as pension income. Please note that this option can result in you paying higher rate tax, may impact on any means tested state benefits you receive and creditors may have a call on this money. This option is normally only available through your existing pension provider.
The flexi-access drawdown plan is designed for the medium to long term to enable your investment time to grow. FAD will enable you the flexibility to take out additional sums in the future, if required, but to avoid taking funds when investment conditions may not be favourable, you could consider placing funds for known future expenditure in a cash fund within your plan.
Q6. Can I take my tax free cash from a flexi-access drawdown plan?
Yes, even if you decide not to take your tax free lump sum at outset, you will have the opportunity to take it later. Alternatively, if you do not need to take your tax free cash as a lump sum, under FAD, you could consider using your tax free lump sum to help provide a tax efficient income over the first few years. Each income payment being 25% tax free and the balance taxable - similar to UFPLS above.
Q7. Can I change my income during the term?
Once the flexi-access drawdown plan is set up, you have the option to change your income level at any time. You can also stop and restart income on request, potentially to help avoid paying higher rate tax.
Q8. What term can I select?
Flexi-access drawdown has no fixed term, although you need to consider investing for the medium to longer term to give your investments the time to grow.
Q9. Can I still make pension contributions?
Yes you can, although if you opt for flexi-access drawdown, the annual allowance, or cap on the amount you can contribute into a pension, of £60,000 pa will be reduced to £10,000 pa. This is called money purchase annual allowance (MPAA) and is triggered on taking up FAD.
Q10. Do individuals have to tell anyone that they’ve triggered the money purchase annual allowance?
Yes. When you first flexibly access your pension, the scheme administrator has to provide a statement to you within 31 days. You then have to notify any other schemes that you’re an active member of (i.e. where contributions are being paid to a money purchase scheme or you’re accruing benefits under a cash balance or hybrid scheme) within 91 days of receiving your statement, so that they’re also aware that the £10,000 money purchase annual allowance will apply.
Q11. What if I have a change of circumstances?
FAD is very flexible. If your circumstances change, you can buy an annuity at any time or transfer to another drawdown pension plan. Please note that if you transfer out in the early years your investments may not have had time to grow and it is likely you will receive less than you paid in.
Q12. What happens to my income on death?
In the event of your death, flexi-access drawdown enables you to pass on your fund to your spouse or partner, or anyone else you nominate. If you die before age 75, your fund can be paid out tax free and if you die post age 75, the lump sum or income would be taxed at your beneficiarys' marginal rate.
If your spouse or other beneficiary takes out another FAD with your fund, on their subsequent death, the remaining fund can be passed on, potentially tax free (if below age 75), to their named beneficiaries, moving down the generations.
Q13. Can I add my own money to purchase another annuity when my plan matures?
If you have other pensions available in the future, you can add them to your residual fund and search again on the open market for another retirement income product.
What are the pros and cons?
FAD is very flexible, but there are risks. The main risk is that as your fund remains invested, the value can go down as well as up, which may result in your fund being depleted over time and not lasting for the rest of your life. FAD may only be suitable if you have a larger pot or other sources of income, and you are comfortable taking some risk with your pot, your retirement income, or both. This option also has ongoing charges applied to administer the plan.
For those wishing to have flexibility, the FAD allows you to keep your options open – you avoid locking in to a lifetime annuity at the outset. In the future, you can shop around again for whatever type of pension product and features match your circumstances at that time.
• You have the ability to vary or take whatever income you choose, whilst your pension fund continues to be invested tax efficiently, with the potential for growth to counteract the effects of inflation.
• You can structure your income to mitigate the liability to personal income tax. By reducing income in some years, you may be able to avoid higher rate tax liability.
• The ability to provide benefits for your spouse/dependents Enhanced death benefits – as above, in the event of your death your fund can be passed on to your nominated beneficiaries, tax free, if before age 75. Alternatively, your beneficiaries can remain in drawdown, free from Inheritance Tax, or purchase an annuity, taxed as above.
• Allows access to your tax free cash, with the option to delay taking any income.
• Capital and/or the income returns are not guaranteed and therefore your income may not last throughout your retirement. If you want a guaranteed income for the rest of your life, you may wish to consider an annuity for all or part of your fund.
• There is an investment risk in that the income and/or fund may fall depending on the performance of the underlying assets.
• High income withdrawals may not be sustainable and may be subject to higher rate tax, potentially at 40 or 45%. You are able to take 25% as tax free cash, but the balance will be treated as taxable income.
• Taking withdrawals may erode the capital value of the fund, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income when an annuity is eventually purchased and could also affect the long-term financial security of your spouse or civil partner/partner.
• The investment returns may be less than those shown in the illustrations.
• If it is decided to purchase an annuity in the future, annuity rates may be at a worse level at that time. Although annuity rates generally increase with age (in keeping with shortening life expectancy), they have fallen dramatically during the past 15 years due, mainly, to falling gilt yields. This trend may continue.
• A careful investment portfolio needs to be constructed which will involve some investment risk. This means the fund value could fall which could affect your future income levels.
• Withdrawing too much income in the early years may have an adverse effect on preserving your pension purchasing power or preserving the capital value of your fund.
• There is no guarantee that your future income will be as high as that offered by an annuity purchased today. You may feel the prospect of the future higher income does not compensate for the known income available from an annuity now and for the rest of your life.
• The Financial Conduct Authority (FCA) has particular concerns in relation to mortality risk. If you purchase an annuity, you may benefit from a cross-subsidy from those annuitants that die relatively early. This cross-subsidy is not present with drawdown and so to provide a comparable income, a higher investment return would be required. The impact of mortality can be expressed as an annual percentage rate by which the net investment performance of the remaining personal pension fund would have to exceed the interest rate implicit in an annuity in order to break even. This effect has become known as ‘mortality drag’.
• This option also has ongoing charges applied to administer the plan. These charges are explicit, whereas under an annuity they are inherent in the annuity rate offered.
• Increased flexibility brings increased costs and the need to review arrangements on an ongoing basis.
• If you are in debt, accessing your pension fund to realise a cash lump sum, may enable creditors to call upon these funds.
• Accessing your pension fund for tax free cash and/or income may affect any means-tested state benefits.
• Please note that following the pensions changes, criminals may be looking to cheat you out of your pension savings. We urge you to be on your guard as once you have been tricked into transferring the money to someone operating a scam, you may lose all your money and could also face a hefty income tax bill. You should only discuss your pension arrangements with a firm authorised by the Financial Conduct Authority (FCA).
• Your investment/s in flexi-access drawdown are covered by the Financial Services Compensation Scheme (FSCS) for a maximum of £50,000 per investment. Please note that this may offer you less protection than an annuity, which as a long term insurance contract, is covered by up to 100%.