The financial decisions you make at retirement will impact you for the next decade or two (and, hopefully, even longer). So, picking a retirement income is a first step towards smart investment, is absolutely crucial to maximize your pension pot. Traditionally most people opt for an Annuity , however, there are big limitations in being stuck with one money source that is paying out a fixed amount.

To be fair, Annuity rates have been on the rise of late, and are still a good option when it comes to taking an income from your pension. However, in order to be able to sustain a higher cost of living in the future, Annuities have failed to give a fair return and left most people feeling the need to make more out of their nest egg.

What is a Pension Drawdown?

Pension Drawdown

Pension drawdown is an investment towards your pension pot which provides you with a regular retirement income by reinvesting it in funds specifically designed and managed for this purpose.Drawdowns are flexible to access when requiredand they let you choose how to invest and what income to take and when. While it exposes considerable risk, drawdown can also give great returns and a hedge against inflation. If you can afford to lose some of your pension, drawdown can potentially increase it.

Choosing Income drawdown or pension drawdown is not a once-in-a-lifetime decision. You can buy an annuity with your fund at any time. So, you could use drawdown to keep your funds invested and take an income from it if annuity rates are particularly low at the time of retirement. Each time you move money into a drawdown, up to 25% can be taken as a tax-free lump sum. The remained stayed invested and taxable income can be drawn directly from the pension. There are certain other pension schemes like Small Self-Administered Pension Scheme (SSAS) set up by a limited company usually for the benefit of the directors and senior employees.

Benefit of a Pension drawdown

  • Allows you to put money off buying an annuity if rates are low
  • Ability to pass more to your family and friends when you die
  • Potential for growth and protection from inflation by remaining invested in the stock
  • You can take this at any point from age 55
  • Flexibility of taking money when you need it a making further contributions when you wish
  • You can see your money grow by investing carefully and regularly review how any income is reducing you pension pot .

How does Pension Drawdown Work?

Of the total amount in your pension, you are entitled to take our 25% as a tax-free lump sum. The remaining 75% can be invested into investment funds in order to provide growth and income in the future. The percentage of funds can be entirely moved to a drawdown at one time, you can mix and match your options, combining a drawdown in part with secure annuity. This largely depends on the amount of income required at different times in the future.

There Are Generally Two Main Types Of Pension Drawdown Products:

1. Flexi-access drawdown : Has no upper limit on how much income that can be taken out from your drawdown funds.

2. Capped drawdown : Has limited to the amount of income that can be taken out. Since April 2015 there are new rules about tax relief on future pension savings if you exceed your income cap

What is Flexi-access drawdown:

Flexi-access drawdown is an option for people who can prove they have sufficient income guaranteed for life such that hey will never fall on state benefits. Introduced in 2011, flexible drawdown allows investors who satisfy the government that they receive a ‘secure pension income’ of £20,000 a year to withdraw as much as they want from their pot, subject to Income Tax at their top rate. Investors can take the entire pot it they wish.

Features of the Flexible Drawdown

  • Investor needs a secure pension income of £20,000 a year gross to qualify.
  • Secure pension income can include state pension, defined benefit pension or an annuity from a life insurer.
  • Investor can make unlimited withdrawals from a drawdown pot subject to income tax at marginal rate.
  • No more pension contributions or accruals permitted once flexible pension is taken.

The Best Time to Choose an Pension Drawdown

The most suitable time for a Pension Drawdown may be under the following circumstances.

  • You are only partly retiring but require some initial income.
  • You are retiring early and consider you can obtain a better annuity when you are older.
  • You think you can obtain better returns than can be bought with an annuity
  • You have experience of investing your pension fund successfully as you are in a SSAS or SIPP
  • You wish to take tax-free cash whilst delaying purchase of an annuity.
  • You wish to protect the majority of your pension fund from your heirs in case you die before 75, especially if you are in poor health (or till your death n case of the open annuity).
  • You require flexibility of income to deal with future expenses or windfalls like a family wedding or maturing investments.

Risks and rewards of Pension Drawdown

Risks and Rewards of Retirement Drawdown

Drawdown is generally considered more risky than buying an annuity and should only be considered by individuals who have got enough assets to be able to afford to take the risk. As a rule of thumb, you need combined pension and other retirement savaging worth £100,000 or more before considering a drawdown.

Structuring your portfolio to make sure it meets your risk/reward profile is more important for people in retirement drawdown than for investors at any other time of their life. The same basic principles of portfolio construction apply for income drawdown as to other pension investments. It is therefore recommended you get financial advice before committing to one.

Drawdown Pension Calculator With The Help Of Case Studies

Case Study 1: Henrik Jackson is aged 65 and is planning to retire

Market Condition: Market rising 10% a year for two years in a row

  • Mr. Jackson has £100,000 in his retirement drawdown fund. After set-up charges he has £97,000, which rises 10% to £106,700. He draws income of 5% at the end of year 1 (£5,335). His fund value at the end of year 1 is £101,365.
  • By the end of year 2 his fund has risen to £109,981 net of charges. His second-year income is £5,499 and his fund value at the end of year 2 after income is deducted is £104,481. (If he has opted to maintain his income at £5,000 his fund value would be even higher.)
  • His fund value has grown by 4.48%.

Case Study 2: George Lucas is aged 68 and is retired.

Market Condition: Market falling 10% a year for 2 years in a row

  • Mr. Lucas has £100,000 in his retirement fund. After set-up charges he has £97,000, which falls 10% to £87,300. He draws income of 5% at the end of year 1 is £82,935.
  • By the end of year 2 his fund has fallen to £73,397 net of charges. His second-year income is £3,700 and his fund value at the end of year 2 after income is deducted is £69,697. (If he had opted to maintain his income at £4,365 his fund value would be even smaller. To the extent, depending on his age and time, GAD limits might not have permitted him to withdraw such a sum.)
  • His fund has fallen by over 30%. But because his principal investment is now so small, it will need to grow in year 3 by 45% before charges and before he gets back to his starting value. (Assuming charges of 3% in year 1 and 1.5% a year later.)

How to Take an Drawdown Income

There are two main ways to get with a drawdown income:

  • Target a series of lump sums at systematic intervals.
  • Use a portion of your pension pot to buy a short-term annuity. This method provides you with a secure regular income for specific period of time like say, up to five years.

Example: you could use a short-term annuity to provide yourself with a basic income and, to top this up, cash in part of the rest of your pot on an irregular basis.

You can carry on using income drawdown for as long as you like. At any time, you can use your remaining pension pot to buy a lifetime annuity. If managing on an income that might go up and down seems too difficult, another option is to use at least some of your pension pot to buy a lifetime annuity immediately.

In Conclusion

Before you commit to anything make sure you fully understand your options. If you are at all uncertain about its suitability under your current circumstances, it is strongly advisable to seek financial advice. You should carefully consider your overall financial situation and other retirement goals or plans when making your decision. Also keep in mind the fees that you will be required to pay. Most investments incur charges, and the income you ultimately receive depends on the returns from investments, less any charges.

Lastly, investment scams do exist. Once money is taken from a pension, it is imperative you’re careful where you re-invest it. These scams are usually done by companies that are not regulated. Warning signs to stay away include cold calling or texting, the promise of unique or unusual opportunities offering quick, easy profits or something which seems too good to be true.

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