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Your Options if you purchased Income Drawdown before April 2105 - Including Death Benefits

The new Income Drawdown rules which come into effect on 6th April 2015 will present customers who already have an Income Drawdown contract some additional options and benefits.

Customers who take out an Income Drawdown policy before 6th April 2015 can still take full advantage of the new rules when they come into force in April 2015. There are no extra costs or charges for doing this.

Customers who take out an income drawdown policy before April 2015, may benefit from making use of some of the old rules, which can continue to be used after April 2015 if it suits them better.

In very simple terms, customers who have taken out an Income Drawdown policy before April 2015 can choose which rules they wish to use – they can have the best of both worlds.

Don’t panic. If you are not making pension contributions, or are contributing less than £10,000 per annum, then this is not likely to have a material impact on you.

Drawdown Pre and Post April 2015

Customers who have taken out Income Drawdown before 6th April 2015 will be in ‘Capped Drawdown’. Capped Drawdown will not be available to new customers after 6th April 2015.

All drawdown contracts started on or after after 6th April 2015 will automatically be in ‘Flexi-Access Drawdown’. This is a new drawdown category.

A customer in Capped Drawdown can convert at any time into Flexi-Access Drawdown. However, once converted to Flexi-Access Drawdown you cannot revert back to Capped Drawdown.

Are you taking an Income Yet ?

The decision on which contract to use only becomes material at the point you decide to take an income from the drawdown.

If you do not want to take an income yet, and you take out your Drawdown contract before April 2015, you will stay in Capped Drawdown until you reach the point where you want an income. At that point you will be able to decide which route you want to use.  If you decide to stay in Capped Drawdown you could still convert to Flexi-Access-Drawdown at a later date.

If you are currently taking an income and a happy with the amount you are receiving you do not need to do anything.

Which Option to Choose

There will be two factors which will determine which income drawdown contract you will want to use - the amount of income you want to take, and / or if you still want to make contributions to any pension savings plan (including recycling income from Drawdown).

Remember no matter how you take money from the remaining 75% of your drawdown fund (single lump sum, regular payments, etc) all withdrawals will be classified as taxable income.

If you have no intention of making any contributions to a future pension plan (including income recycling), then you can jump straight to the ‘Income Choices” section below.

If you still want to make pension contributions?

If you are not taking any income from your Drawdown contract and want to make contributions to your Income Drawdown contract, or any other pension contract, then the maximum you can put in is £40,000 per annum including tax relief. This is known as the ‘Annual Allowance’.

If you take an income from Capped Drawdown, and do not exceed the Capped Drawdown Income limit (see below), then you could still contribute up to £40,000 (including tax relief) per annum into pension savings.

If you take more income from your Capped Drawdown than the income limit (below), then your plan automatically converts to Flexi-Access Drawdown and the maximum you can contribute into any pension contract (whilst still receiving tax relief) will reduce to £10,000 per annum. This is known at the Money Purchase Annual Allowance (MPAA).

For the avoidance of doubt, the moment you exceed the income limit in Capped Drawdown, or you take one penny as income from Flexi-Access Drawdown, the maximum you can contribute into any pension plan (whilst still receiving tax relief) is £10,000 per annum.

Why is this important?

If you are not making pension contributions, then the only issue that will determine which contract you use will be the amount of income you take at the point you decide to take it.

If you are making annual pension contributions of less than £10,000 per annum after tax relief (including recycled income from drawdown), and you don’t feel you will ever exceed £10,000 per annum, then again, it really doesn’t matter which contract you use.

If you are contributing more than £10,000 per annum into pension savings, then you may not want to lose up to £30,000 of annual allowance that earns tax relief. In this case you may want to ensure that you do not break the income rules associated with your Capped Drawdown contract. Please see below.

Income Choices

If you are in Capped Drawdown and not taking an income yet, then you will remain in your current contract.

If you are in Capped Drawdown and want to take an income or a lump sum (not to be confused with 25% tax free cash), then you will either remain in Capped Drawdown or be automatically transferred to Flexi-Access Drawdown depending on the amount of income you take. Again, like all income, this is liable to income tax.

If you are in Capped Drawdown and want to take an income, and want to stay in Capped Drawdown to take advantage of the higher annual allowance, then you will need to stick to the income rules, often referred to as the GAD rules.  

With Capped Drawdown the amount you can take from your drawdown contract is set by the Government Actuarial Department, commonly referred to as GAD. This department produces tables to be used by insurers that tells them the rate to use when calculating your income. Very simply the amount of income you can receive will be based upon your age, your life expectancy according to GAD and the value of the fund. Your insurer must perform regular reviews on the income you can take. Changes to the three variables above could cause the income you receive to rise or fall. For example as you get older you would expect your income to rise, however if your fund has fallen since your last review, then you could see your income go down. Likewise good fund growth could cause your income to rise. These GAD charts are regularly reviewed.

When you start to receive the income from your drawdown fund, you can receive anything from 1% to 150% of the rate indicted by GAD. To put this simply, if when applying for your monthly income, your fund size and the GAD tables indicate that your monthly income should be £100 per month, you can opt to take anything between £1 and £150 per month. We will help calculate GAD incomes for those customers in Capped Drawdown.

The drawdown provider is required by law to review the GAD rate (if you choose to use it) at least every 3 years and annually once you are aged 75 or over. You can choose how much income you want up to the maximum indicated by the review. You can turn the income off if you wish. You may not be able to increase or turn the income back on between reviews. You can however request one review during a tax year even if your compulsory three year review is not yet due. 

Death Benefits

One of the primary considerations of any financial contract is what happens to the money when you die. The following rules apply to both Capped and Flexi-Access Drawdown.

The income paid from an income drawdown contract is based solely on you. Unlike an annuity, drawdown contracts do not have spouse’s pensions or guarantee periods, and all income payments stop when you die. Equally unlike an annuity, the unused income drawdown fund is still available to your family and estate on your death.

The people you leave behind may have to pay tax on any pension fund of yours they inherit depending on your age when you die and how they choose to use the fund.

No matter how the people who inherit your pension fund choose to use it, it will not be subject to inheritance tax, as pensions plans are held in trust and therefore do not form part of your estate.

Furthermore if your beneficiaries choose to use your fund to buy a pension product in their name then, in all instances, there is no tax to pay on the amount they receive.

If your beneficiaries choose to take the fund as a lump sum, then any tax payable will depend on your age when you die:

If you die before age 75 - and the person who inherits the pension takes it as a lump sum, then they can take the fund in full with no tax charge whatsoever.

If you die aged 75 or older - then the person receiving the fund will pay tax. If they inherit the fund during the tax year 2015 - 2016, and want it as a lump sum, they will pay a flat rate of tax of 45%. From tax year 2016 – 2017 onwards, people receiving a fund from somebody aged 75 or over will pay tax at their marginal rate. This means that if they had very little other income they could pay no tax, or at the starting rate of 10%. In all cases the maximum that could be paid in tax (based on current tax rates) would be 45%.

These changes only apply to beneficiaries who want to inherit a pension fund as a lump sum. People who want to use the fund to provide themselves with a pension income will continue to pay income tax on the money they take at their marginal tax rate.

Summary

We have tried to keep this document simple while giving you sufficient information to see if any of this applies to you and to prompt further questions if necessary.

In essence, you will only be interested in the drawdown contract you have if you are still making, or plan to make pension contributions into your drawdown contract or any other pension contract. We believe that one by-product of the new pension rules is that they make saving into pensions a very sensible and attractive decision. We will publish further information on this on our website in due course.

If you have any questions about this document, the new pension rules, or anything to do with retirement planning and the service we offer, we would be more than pleased to hear from you.

Please Note : The limits and allowances discussed in this document apply for the tax years 2014 – 15 and 2015 -16. These limits could be subject to change, revision or removal by future governments.

By Bob Cook
Published : 20th January 2015
Nothing in this article should be taken as personal advice and recommendation. UK tax rates and pension legislation are liable to change and concepts, rates, legislation and rules referred to may not be current at the time you read this article.
 

 

 
 
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