Getting the best from your scheme
Pension drawdown – taking a regular income from your pension savings without buying an annuity – has become very popular in recent years.
Drawdown schemes can offer valuable flexibility. But investors need to be careful about the amount they draw because the size of the overall pension fund may decline, depending on how the monies are invested. In other words, you may get the same monthly income, but the return on your investments and the size of your capital fund may fall substantially. As a result, the capital remaining to generate future income could be depleted earlier than anticipated.
Here are ten things to consider if you have a pension drawdown arrangement.
1. Remember the risks
It's essential to understand the relationship between your total return on your underlying investments and the income being taken. If your income is greater than the total return at any given time, your capital may be depleted earlier than anticipated.
2. Understand the importance of maintaining the capital sum
Try not to drawdown more than the natural income yield from the assets during the first few years of drawdown. You need to try to ensure that the underlying capital keeps up with inflation, so that the income which that capital can generate also has scope to rise in line with the cost of living.
3. Remember the GAD rate is higher than the current annuity rate
If you draw the maximum Government Actuary's Department rate (e.g. 6.1% for a male aged 65), it's unlikely to be sustainable as you'll almost certainly be subsidising the income on your investments by taking a significant amount of the capital each month.
4. Compare any drawdown rate with index-linked annuities
If you draw substantially more than the index-linked annuity rate, the capital in your fund is unlikely to be maintained in real terms, i.e. adjusted for inflation over an extended period. You may need to fall back on other funds to sustain your retirement.
5. Ensure the fund remains well balanced
As your drawdown arrangement needs to provide you with a regular income, it can be tempting to liquidate incomegenerating investments, for example, in preference to other holdings which may be less liquid. This may create a good income flow in the short term, but you need to ensure the remaining investments remain well balanced to support you in the future.
6. Get an estimate of the full charges before signing up
This includes checking the underlying costs of specific investments within your fund. For example, investing heavily in pooled or bond funds may spread risk but can also increase your underlying costs.
7. Review your fund regularly
If you want your pension fund to last for a certain number of years, you need to have a clear understanding of the nature of the investments within your portfolio and the ability of those investments to generate a reliable stream of income.
8. Keep an eye on annuity levels
Drawdown has many benefits, but it's possible to transfer at any time to an annuity, which gives you certainty by providing a guaranteed income for the rest of your life.
9. Drawdown is as good as your investment manager
Ultimately, the performance of your investments and the amount you can draw depend on the success of your investment manager. If you're unhappy, you can always change your investment adviser.
10. Don't forget about tax
Despite the above, there can of course be good reasons for stripping the fund quickly, depending on circumstances, such as poor health. As a result, some people are keen to draw out as much as they can each year to deplete the fund, to avoid an ultimate 55% tax charge on death.
Some people are also taking maximum income and then gifting it, to take advantage of the rule allowing regular gifts from surplus income to fall outside the IHT net. However, bear in mind that unvested pension funds can be passed on IHT-free on death before the age of 75. Therefore, a pension fund is very tax efficient if income from this source is not required. Also remember that, once you begin to draw income down, that income is taxable at your marginal income tax rate.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
