Income Drawdown
You do not have to buy an annuity straight away when you want to start taking an
income from your pension fund.
Historically, in order to access the tax-free lump sum within a
pension plan an individual was forced to purchase an
annuity (pension income) at the same time. This was
not always suitable for many people who may have wished to utilise the lump sum
but have no need for income at the same time.
New pension rules that came into effect in 2006 now allow individuals to
transfer benefits into an Income Drawdown contract, taking up to 25% of the fund
value immediately as a tax free lump sum (Pension Commencement Lump Sum),
without the requirement to purchase an annuity.
This is called crystallising your benefit and once the tax-free cash has been
drawn down you have the option of taking an income, a minimum income or no
income at all. However, in the event of your demise your widow would have the
option of purchasing an annuity with the remaining fund for which there would be
no tax charge, or taking the balance of the fund, less a tax charge of 35%. This
differs to the situation prior to taking tax-free cash.
The individual has the option to draw an income from the remaining fund whilst
leaving the fund actively invested to achieve future growth. An income of
between nil and 120% of the equivalent available annuity can be drawn in any
year. This can continue to the individuals 75th birthday, by which time an
annuity must be purchased. The individual has the flexibility to secure the
annuity at any time before reaching age 75.
Remaining invested within an Income Drawdown contract does involve a degree of
investment risk, though this can be removed by investing 100% into a Cash Fund.
Clearly, investing into a secure Cash Fund removes risk but similarly restricts
potential growth to typical current interest savings rates. Investing into
higher risk funds enables individuals to maximise potential for growth on their
remaining funds in order to try and establish a higher eventual pension. A
further risk of investing into Income Drawdown is the possibility of reductions
in future annuity rates, which means that less annual income can be purchased
for the same fund values.
Taking your benefits
You can currently take your benefits from age 50 although this will increase to
55 from 2010. When benefits are purchased you have the option of taking up to
25% of the fund value as an immediate tax-free lump sum with the balance being
used to purchase an annuity which is guaranteed to
be payable until death.
Most people will also receive the benefit of the basic State pension which is
built up over a number of years by way of National Insurance contributions
towards a State pension. This benefit is earnings related based on the number of
years contributed and the level of National Insurance paid. To find out how much
your State pension is worth you can apply to The Pension Service and ask for a
form BR19 and they will send you a projection of your pension. Please ask us for
further details.
If you have held your pension for a number of years the charges on the contract
will almost certainly be higher than that on a modern day equivalent. A number
of insurance companies are now closed to new business, people such as Abbey
Life, Abbey, NPI, Pearl, Scottish Mutual, Scottish Provident, Eagle Star, which
ensures that these companies are not required to compete in the market place on
investment performance and therefore returns tend to be somewhat lower than the
sector averages.
If you would like to discuss your pension drawdown options then please
contact us.