|For some people, taking all of their pension in one go may not be the best for their personal situation. You may decide that some form of phased retirement, or a method of slowly increasing your pension over time, is your best option.
You may decide that leaving your pension fund (or some of it) for the future is exactly what you want. For example, you may have an alternative source of income, or rather than giving up work, you may slowly reduce the hours you work.
In our experience most people will be clear on how they will deal with their tax free cash, and therefore this section will only focus on the options around managing your monthly pension income.
The first thing to remember is that if you are looking to take a smaller income which will increase over time, then an index linked Pension Annuity may suit you. The pension will start at a lower level and will increase each year with inflation.
If you are looking for a more sophisticated approach, then using a Drawdown contract could be the answer.
WARNING : Income Drawdown contracts are very sophisticated products and carry a significantly higher degree of risk than an annuity contract. See Income Drawdown Risk below. Our standard service is to offer Income Drawdown without advice. It is for the customer to decide if the product is appropriate to their needs and circumstances. If you are at all uncertain about income drawdown or if it is appropriate for your needs, we strongly recommend you seek financial advice.
Unlike an annuity where you exchange all of your pension fund (after any pre-commencment lump sum) for a monthly income, the Drawdown contract will allow you to take an income directly from the drawdown pension fund. The rest of the fund remains invested and hopefully, with prudent fund management, it will continue to grow. Of course your fund could also lose money thereby eroding your income in retirement.
In April 2011, the Government changed the rules on the income you could take from a Drawdown contract. Very simply, if you have over £20,000 income per annum coming from other pension sources then the income you take from your income drawdown contract is classified as "Flexible". This is known as the Minimum Income Requirement (MIR) for more details please see below.This means the the Government Actuary’s Department (GAD) rules (discussed below) don't apply and you could take as much income from your fund as you wished. However it should be remembered that any amount taken will be treated as earned income and therefore taxable. This could push you into higher rate tax.
If you feel you will qualify for Flexible Drawdown please make sure you fully understand the Minimum Income Requirement.
For those people who do not have £20,000 per annum from alternative pension sources, the income you take from a Drawdown contract is classified as "Capped". In this situation you must abide by the GAD rules. In our experience most customers would not qualify for "Flexible" Drawdown.
The government sets limits on the minimum and maximum amounts you can take from your drawdown fund, depending on your age. The limits are set by the Government Actuary’s Department (GAD) and indicate what percentage of your pension fund can be taken as income, based on your age. Don’t worry, your Drawdown provider will calculate all this for you, although the tables are available to download from the Government Actuary Department if you are interested.
The amount you can take is specified as a percentage of Government Actuary’s Department or GAD. Once set, you have a choice about how much of GAD you want to take within a specified range. The range goes from 0% GAD to 120% GAD.
This means that if the GAD table indicated that, based on your age and the size of your Drawdown pension fund, you can take £1,000 income per month, then you can select anywhere between £0 per month (0% GAD) or £1,200 per month (120% GAD).
If your fund allowed for £1,000 per month to be paid, but you only needed £400 per month, we would set your initial income level at 40% GAD. You can alter this amount each year. Most providers review your overall GAD entitlement every 5 years. This review could result in the income you are taking either increasing or decreasing. This will mainly depend on the value of your fund.
You cannot add any un-taken income in one year onto the income of another year. For example, if you could take an income of £900 per month but only chose to take £400, you could not add the £500 per month onto the income you took in the next year, i.e. If 120% of GAD in the following year was £1,200 per month, you couldn’t take that plus the £500 that you didn’t take in the previous year.
Minimum Income Requirement (MIR)
To qualify for and use flexible income drawdown you must :
- have a minimum income secured through other pension means of at least £20,000 pa. Income taken under this option is also taxed at your highest marginal rate.
- have paid no contributions (or had any contributions paid on your behalf) in the same tax year in which flexible drawdown is to be taken.
- to be eligible you must also not be an active member of a defined benefit or cash balance scheme. Contributions made into a money purchase scheme, made in the same tax year as the election to use flexible drawdown will be subject to an Annual Allowance tax charge taxed at the highest marginal rate, resulting in no financial gain.
If you do not meet the criteria above your Income Drawdown contract would be classified as "Capped"
For some people, particularly those with large pension funds, they do not like the idea of a conventional annuity where the entire fund is given to the annuity provider, because under certain circumstances, should you die, you run the risk of the remaining fund being lost to your estate.
The Drawdown option keeps the asset within your estate and within your control. If the fund is still in place at the time that you die, the fund value will pass to your estate. Depending on who receives the fund on death and how it used, will depend if and how it is taxed. If it is taken as a lump sum, based on current rates, it would be taxed at 55%. Nevertheless some people still find this an attractive option compared to losing all of the fund to an annuity company.