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Flexible drawdown: the holy grail for retirees?

A pension policy that offers both flexibility and a guaranteed income – surely it's too good to be true?

 

by Michelle McGagh on Oct 30, 2012 at 09:03

Flexible drawdown: the holy grail for retirees?

Pension drawdown has become a popular alternative to annuities, but as the government reduces the amount of income that can be taken each year, flexible drawdown may be a better option for those who can afford it.

Drawdown allows retirees to keep their pension invested and take an income from it each year. The amount of income that can be taken from an income drawdown policy is based on calculations made by the Government Actuary’s Department (GAD), known as GAD rates.

These GAD rates are linked to the annuity rates offered by insurance companies, which have fallen dramatically.

Drawdown income hit

As annuity rates fall drawdown income also falls, and drawdown income has also been hit by a government decision to reduce the amount of income that can be taken each year from 120% of the GAD rate to 100% of the GAD rate.

This option is known as ‘capped drawdown’ because the amount of income that can be taken is capped, and it is losing its appeal to many who thought it would offer a real alternative to annuities.

The flexible option

But there is another option: flexible drawdown. Flexible drawdown allows pensioners to navigate around the income limit and take whatever income they like each year. The only caveat is that the pensioner must have £20,000 of yearly income secured elsewhere, which may be a workplace pension or the state pension with other smaller pension pots tacked on.

The £20,000 doesn’t have to be all in one place, it can be a number of different pots, and it is meant to ensure that you don’t run out of money in retirement and fall back on the state.

Alastair Black, head of decumulation at Standard Life, which has just launched a flexible drawdown pension product, said most people have more than one pension and may use one pot to buy an annuity and secure an income of £20,000 – which would amount to a pension of around £500,000 – and then place the rest of their pension in flexible drawdown.

Can you afford it?

‘The guaranteed income needs to be in pay,’ Black said. ‘A lot of people will be in defined contribution pension, which makes you take more decisions about your pension, and will have the state pension and together they will make up £20,000. They will need to quite rich to use flexible drawdown.’

Black said flexible drawdown is a way to provide comfort and flexibility to retirees. ‘In our survey of what customers in retirement, first they need a base level of comfort. With the money they have saved all their life they want to receive a base income – that is where the £20,000 guaranteed income comes in,’ Black said.

‘They also want to spend their money when they want spend it and pass some of it on to their family. They can do that with flexible drawdown.’

What’s the catch?

For those who have the guaranteed £20,000 income and can afford to take flexible drawdown, it may look a bit too good to be true. Well, there are some catches.

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30 comments so far. Why not have your say?

jeffian

Oct 30, 2012 at 10:48

"Alasdair Black, head of decumulation at Standard Life........"

Head of what?!

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Anonymous 1 needed this 'off the record'

Oct 30, 2012 at 12:22

It is interesting to see whether such a scheme can be integrated into death tax planning. The aim is to ensure that when you and your spouse die, there is only about £650K left in assets. So, e.g. starting with present assets, say £1M, and the pension of say £30K, and a willingness to annually PET to the children the optimum amount, while keeping aside cash to pay for health care, say £60K p.a. then there will be a probability function of life expectancy versus assets versus drawdown rate - is there somebody out there who has the spread-sheet required to do this game theory calculation?

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bigand

Oct 30, 2012 at 12:43

The problem for me is that I want to retire at 60 but my 20K PA will only be reached when I include my state pension at the age of 67. So 60 thru 67 what money do I live off - perhaps my 25% tax free lump sum, but really I would just want to get at my flexible drawdown and take whatever money I need (subject to tax) This is where I see the flaw.

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LouisV-W4

Oct 30, 2012 at 15:50

"There is also a caution for people who are embarking on phased retirement... You are not supposed to make any pension contributions in the tax year that you take flexible drawdown. Although you can still take income up to the capped limit you cannot draw anything over this, and it will incur a penalty as an unauthorised payment."

I don't understand this!

Does this mean my employer (me) has to stop paying pension contributions?

Also, if I need £20K to qualify for Flexible Drawdown, but whatever I decide to draw is capped at the same GAD rate as for capped drawdown, how is Flexible Drawdown of any value? Am I missing something crucial here?

It's something very close to my heart as I've just taken my tax free lump sum but held off taking any drawdown income for now.

I am working part-time, but take dividends + minimum threshold salary, rather than a £20K+ salary. I want to take Flexible Drawdown for similar reasons to 'anonymous 1', and also to ensure I don't leave anything in my pension pot to be taxed at 55%, but have been advised I cannot because my income is too low. Hence, my reason for holding off for now, albeit I note the point about being able to switch from capped to flexible but not vice versa.

There are a lot of very informed financial wizzes on this site.

So, can someone please answer my very simple question:

If I have an income of £20K comprising dividends and salary, can I take Flexible Drawdown?

If not, would it be tax-efficient to revert to £20K salary with reduced dividends, and pay PAYE rather Corporation Tax?

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bigand

Oct 30, 2012 at 16:29

LouisV-W4

My understanding is that the income that counts towards your £20K can be State Pension, Annuities and Defined benefit pensions. I do not believe a part time job counts towards it or other forms of income as they are not guaranteed. The state wants to make sure that if you blow everything you will still have £20K PA and therefore do not need state help.

I do not believe that flexible drawdown is capped, I believe you could take the lot, but you would be paying tax on it at 20/40/50% depending on how much you take.

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sloccy123

Oct 30, 2012 at 16:35

No one has mentioned the 55 % tax charge when you pass on???

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LouisV-W4

Oct 30, 2012 at 17:21

Thanks 'bigand'. Not what I wanted to hear, but I understand the misguided thinking.

Anyone who has been responsible enough to sacrifice and save for 40 years towards a pension is perceived by Government as suddenly becoming financially irresponsible! However quickly I draw down my pension pot, I will still have the same state pension as others, and presumaby more through the secondary pension.

'sloccy123' - I mentioned the 55% charge above!

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LouisV-W4

Oct 30, 2012 at 17:22

'bigand' - I didn't mean you are misguided!!

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AKW

Oct 30, 2012 at 17:31

As I understand it you are only subject to the 55% tax at death if you are 75 or over?

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bigand

Oct 30, 2012 at 17:35

LouisV-W4 -it wouldn't be the first time if I was!

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jeffian

Oct 30, 2012 at 17:37

LouisV,

I am in Flexible Drawdown so I can answer some of your questions -

1) You can only enter into Flexible Drawdown if you are making no further pension contributions into any scheme so, yes, it does mean that your employer (you) has to stop making pension contributions. Furthermore, you cannot just stop contributions and start drawdown; there have to be no contributions within that financial year (i.e. you will have to wait until the beginning of the next financial year to begin drawdown).

2) Flexible Drawdown is not capped in any way. You can draw it all down if you want.

3) The qualifying income of £20k required to permit FD must be in the form of a guaranteed income such as an annuity, state pension or defined benefit pension. Dividends and salaries don't count.

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hooligan

Oct 30, 2012 at 18:48

seems like (temporary?) migration to a favourable QROPS country wouldnt be a bad idea; why pay any tax at all (dodgy) or pay a much reduced rate of tax in those countries that treat their elders (and their hard earned and accumulated capital) with respect.

i have no affilaition with these people and cannot vouch for them, but, as a starting point, for those so inclined, here is a web address that might work.

http://www.qrops.net/

maybe I could get everyone who uses to pay me say 10% of the extra money! Now if only it would be possible to design a simple spreadsheet to work out the before (here) and after (over there) position!

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MikeR

Oct 30, 2012 at 19:30

I could make the comment that those of us NOT having a 20k income in addition to our drawdown pensions need access to our money more than those who have the 20k.

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LouisV-W4

Oct 30, 2012 at 19:35

Thanks jeffian for answering my questions.

Looks like I will be stuck with capped drawdown until I pop off, and what's left will be taxed at 55%. I'm assuming we won't have any success with the petition to bring back the 120% of GAD any time soon. So, I guess I should start taking the full amount and stop paying my employer's contribution ASAP.

Subject to recycling rules, I believe I could open up another pension plan and take the 25% tax free lump sum at a future point.

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LouisV-W4

Oct 30, 2012 at 19:39

MikeR - your point is well made, which is why I am still working.

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jeffian

Oct 30, 2012 at 19:51

I don't know, Louis. Capped drawdown seems the worst of all worlds to me - probably less income than you could generate from your investments yourself and subject to further Govt interference over the years. Almost as bad as the current cr@p annuity rates with the only benefit that you retain ownership of the capital.

My comments were specifically for Flexible Drawdown. I don't know the rules for Drawdown; they may be different.

Ref your final para, the Flexible Drawdown rules prevent you entering into any new pensions in the future. Once, you're in drawdown, that's it.

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eilidh

Oct 31, 2012 at 09:41

I am 72 and have several health problems and am in drawdown with a poor maximum GAD rate. I am considering buying an impaired life annuity with some of my fund to make up the 20k necessary. As my life expectancy is reduced I will be able to drawdown the rest flexibly and hopefully there will be nothing left for the taxman when I die!

Does anyone else have experience of this plan? Thanks

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Polly

Oct 31, 2012 at 18:10

eilidh

You are spot on with your thinking and that is a very good way to use your pesnion and you be in control of the amount of income that you take, and when you take it. If you don't have a spouse or civil partner to leave your drawdown to it will be taxed at 55% therefore even if you draw out the whole amount and pay 50% (45%next April) you will still be better off (as long as you spend it and don't then pay IHT on the taxed pension income). There is lots of tax planning that you can do to offset the tax and get the money out of your estate (if that is a concern), but the best benefit has to be that you are in control and there is no more triannual reviews (annual review after 75!). Take it and enjoy!!

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LouisV-W4

Oct 31, 2012 at 19:23

I'm with you Eilidh. It's just a shame that you need to have health problems to achieve a higher annuity income.

Just a point about drawdown vs annuties.

If you have a health problem, you will get a higher income from an annuity, which is based on GAD rates. Are you able to claim an impaired health Drawdown rate if your health deteriorates between valuations?

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Polly

Oct 31, 2012 at 20:17

Louis - yes it is called a scheme pension and there are a few companies that will provide these for you and the level of inome is based on your health. However it is still not as flexible as flexible drawdown!

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eilidh

Oct 31, 2012 at 22:06

Thank you Louis and Polly for your helpful input.

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LouisV-W4

Nov 01, 2012 at 11:54

Polly, thanks for your input. Useful to know, should my health deteriorate.

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Dr Jimbo

Nov 03, 2012 at 16:35

I made the following comment on the subject "Would you want your pension fund invested in housebuilding" which appeared in tandem with this blog. Here 'tis...

The impact of Government drawdown allowances on Self Invested Pensions (SIPPS) and their equivalents is little understood, by the way. Because the Government is manipulating Gilt index yields to such a low level (currently about 2.5%) a 68 year old can only drawdown £60 per £1000 of pension held in his pension pot.

The drawdown rates (GAD rates) at this Gilt yield rate rise over time from £60 to £141 per £1000 by the time he is 85. Even if the money is just left as idle cash, the calculations show that as the pension pot depeletes he can draw less and less each year despite the GAD rate rising. This means he still has over £18,000 in his pension pot at 85; and as the drawdown rate is frozen from then on he cannot live long enough to withdraw all his pension moneys.

If the pension pot is invested at 6% per annum he ends up at 85 with over half his pension pot still in place - a nice gift to the annuity providers if he then dies or a handsome present to the treasury at 55% if he is still in drawdown. !

Note: The £18000 is whats left over if interest on the pension pot is zero and £50,000 is left if it grows at 6%. With the GAD rates at 2.5% and the drawdown limits as set in the tables for a gilt rate of 2.5% you can never get your money back!

if gilts hit 6% (woopee!) the maximum drawdown rate for an 85 year old man is £169 per £1000 in the pot. But he can still never get the last £1000 pounds out unless his name is Methusela.

What this demonstrates is that the Government is hell bent on ensuring you can never get all your pension moneys back becasue they want to see it used to ensure the State does not have to pay for your support. If you are rich, however, and have means to put the £20k insurance in place you can get at all the rest of your pension moneys and spend it when you like,

This is an appalling example of one rule for the rich and another for the rest. We really must get a website together that enables the man in the street to see the futility of saving money in a pension. Forget the illusory benefit of the tax free savings benefit. Look at the complete loss of control it results in. The ordinary many in the street is better off putting everything in ISAS (while this is still an option) or buying into a long-lived asset like property which can be realised whenever its needed.

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Fund of Funds

Nov 04, 2012 at 14:14

If you have a spouse and go into drawdown then you give up the right to pass on that fund to your spouse tax free. This is only an advantage if you can afford to leave all or even some of your fund without taking drawdown. I assume this is the same whether you take the standard drawdown or flexible. If your spouse wants your drawdown funds after your death then she has to pay 55% tax or she can carry on with the drawdown arrangement or buy an annuity.

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Dr Jimbo

Nov 04, 2012 at 18:11

What is dreadful about this 55% tax regime is that a husband and wife used to considered as a single entity for life. What loving husband wold not pass his entire estate to his wife - to have and to hold etc? - This separates them for the benefit of the Treasury. No doubt the excuse is the benefit that was supposedly given to married couples to separate their tax affairs to reduce tax when they were both earning. The sting is in the tail!

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LouisV-W4

Nov 05, 2012 at 10:48

Great explanation above Dr Jimbo. It puts the technical detail behind what I had already concluded; as I don't have the £20K income, I won't be able to exhaust my pension pot, even after taking my tax-free lump sum. So, best to start Drawdown now.

Taking this a step further. If I know I will have additional non-pension income (e.g. part time work and sell shares/property) during Drawdown, and I know I will be in Drawdown at roughly the same amount for the next 30 years, does it really matter if my funds perform at 3% or 23% if I cannot spend it? Surely, I am paying costly fund management charges solely for the benefit of the Treasury! Would it not be better to put it in cash or something equally boring but safe, and forget about worrying if my fund is up or down?

Not what my SIPP provider wants to hear though!

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Alasdair Adam

May 28, 2013 at 00:11

Flexible--

1. Using my OAP and a GAR I am well over the £20K, but intend not to to take any TFC from this plan. Ihave a SIPP, which I do not currently intend to "open" am I debarred from taking TFC in my third and main fund? I had contemplated taking TFC from it only for the first two years concurrently cashing in a Bond on which Basic Rate Tax is deemed to have been paid--this to avoid the higher rate tax on the bond proceeds, which I would conventionally invest or put in my ISA.

2. Is the TFC entitlement specific to ay part of pension priovision or can it be loaded onto one part of one's overall provision? I am thinking of the previous point that I do not intend to take TFC from one of my plans.

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orchardsparks

Apr 24, 2015 at 07:01

Is a married couple's joint income taken into account if one of them wants to go into flexible drawdown?

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jeffian

Apr 24, 2015 at 09:17

Under the old rules it wouldn't have been but since 6 April you are free to do what you like. There is no minimum income requirement now.

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orchardsparks

Apr 24, 2015 at 09:57

Thanks. I've just put telephone down to SIPP provider confirming what I have now read from you. I hadn't realised how out of date this blog was.

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