1. Take up to 25% tax-free cash of the retirement savings you move into drawdown
2. Choose the funds you invest in
3. Set the level of income you want to receive – the pension company will pay the income to you but it will be taxed. You’ll pay tax on any income you take through PAYE – or Pay As You Earn, just as you do when you’re employed
4. Decide if you want to take a one-off withdrawal – this will also be taxed as described above.
5. You remain in control of your pension fund and you need to ensure your funds are performing as expected, and they’re continuing to support your income requirements
If it suits your needs, you can usually combine flexi-access drawdown with an annuity. One part of your pension savings can be used to buy an annuity, providing you with a guaranteed level of secure income for life or a fixed term, possibly to cover your essential living costs. The rest of your pension savings can then be placed into flexi-access drawdown to provide flexible additional income to supplement your annuity income.
Use your tax-free cash to help your fund grow
The more you invest in your fund and the less you withdraw, especially from the outset, the greater its potential growth. This could make your fund more sustainable to support your future income needs. You might wish to defer taking some of your 25% tax-free cash at the outset and allow the amount not taken to grow free from income and capital gains tax within the fund.
Planning for a long life
Unlike a lifetime annuity, flexi-access drawdown does not guarantee you a secure and guaranteed income for life. Because you are in control of your pension fund, you might want it to be capable of providing income regardless of how long you live, especially if investment returns in the future are low and you live longer than expected. It’s important to remember that with income drawdown, your pension savings can be lost whereas with a lifetime annuity, you will never run out of money.
Flexi-access drawdown has ongoing costs
The flexibility and potential for growth offered by flexi-access drawdown has a cost. Charges for arranging your plan and for on-going administration and investment management will be deducted from your drawdown account. Low charges are therefore important and you will ideally need extra fund growth to make up for them. Charges could effectively rule out drawdown as an option if your pension fund is relatively small (typically below £50,000 after tax-free cash).
The effects of inflation and inadequate investment growth
Although the last few years have witnessed low rates of inflation, you should also be aware of the possible damaging effects of future inflation, which may reduce the buying power of your pension pot and the income it pays you.
Under flexi-access drawdown you might need to make sustainable withdrawals for the rest of your lifetime. Your investment fund may not perform as well as anticipated and if you are taking an income or ad hoc cash withdrawals in excess of investment growth and charges, it will inevitably deplete the value of your pension fund over time and it could run out of money.
Any other sources of income
If your drawdown pot runs out, will you have any other income you can rely on? Because of the risks with drawdown, you should consider other income you may get and when you’ll receive it. For example, state or final salary pension, income from property, ISA’s or other investments, or perhaps you’ll still be receiving a salary?
Understanding how much income you get from other sources should help you manage how much you need to take from your drawdown pot.
Understanding your investments
You’ll need to make sure you choose the right investments to match your attitude to risk and hopefully secure the investment growth you need to meet your income requirements. Investments are complex but generally those with greater risk produce higher returns but usually with a more uncomfortable ride than those with lower risk.
Are you prepared to lose some or all of your savings if you make the wrong decision?
Even taking a safe route like keeping your pension savings in a cash savings account carries a significant risk, because the income withdrawals will reduce its value and if the interest rate is less than the rate of inflation, it can cause the real value of your fund to fall over time.
Impact on state benefits and on debts
Taking income or other withdrawals from your drawdown plan may affect any means tested state benefits to which you are entitled and could result in these benefits being lost. You should check the conditions of any benefits you receive before you take any money from your plan.
Money held within your pension fund is not considered part of your regular income or savings and cannot be claimed by creditors or anyone to whom you owe money. Taking money from your drawdown plan could allow creditors to claim it from you.
Are you in capped drawdown?
Capped drawdown is a type of drawdown which allows you to take an income that’s capped at a maximum of 150% of the value of an equivalent annuity. Using capped drawdown will not affect how much can be paid
into a pension in the future.
Although it’s no longer available to new customers, if you already have a capped drawdown plan, you will remain in it unless you switch to the new ‘flexi-access drawdown’.