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Income Drawdown - A Quick Guide
Pension Income Drawdown
This involves you taking up to 25 per cent of your fund as tax free cash, and leaving the remainder of your pension fund invested. In the meantime, you can take income as and when you need it from the fund, subject to certain Inland Revenue limits, but you are not obliged to take income each year. If you want, you can choose to take no income at all for as long as you like until age 75 when you are obliged to either buy an annuity or transfer the fund to an Alternatively Secured Pension or ASP.
The minimum income you can take from an unsecured pension is zero and the maximum is roughly 120 per cent of what a single, level annuity would pay someone of your age. Unsecured pensions replaced "income drawdown" when the new rules for pension simplification came into force on 6 April 2006.
The advantages of taking Pension Income Drawdown
Taking an unsecured pension has a number of advantages including:
- income flexibility - each year the amount of income taken can be varied between the minimum and maximum limits. Income can also be taken monthly, quarterly, half yearly or annually.
- control over your investments - if the unsecured pension is set up through a self invested personal pension or Sipp, there is a wide range of investment options available.
- choice of death benefits - unlike annuities where the only death benefits available are from a joint life, guaranteed, or money back annuity, drawdown offers a choice of death benefits.
The disadvantages
When you buy an annuity, you give up control of your pension fund in return for a secure income. With an unsecured pension, you maintain control of the pension fund but your income will not be secure, so it is a much more risky option than buying an annuity.
There are a number of risks involved when you defer an annuity purchase by investing in an income drawdown plan. Understanding and knowing how to manage these risks is very important.
- Investment risk – the value of your investments can go down as well as up.
- Mortality drag - if you defer purchasing an annuity, you will miss out on the mortality cross subsidy. The extra return required to compensate for the absence of this subsidy is called mortality drag.
- Decrease in your annuity purchasing power – If annuity rates fall and the value of your pension fund does not increase sufficiently to compensate, an annuity purchased in later years will provide less income compared to purchasing an annuity now.
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