Techzone

What is income drawdown?

It's an option available under some money purchase pension schemes which allows a pension to be paid directly from the fund. It's not possible to use income drawdown under a defined benefit (DB) scheme.

The fund, less any tax-free cash taken, remains invested in a tax advantaged environment and the member can simply draw money directly from it when needed. This means that the fund can be managed and will benefit from any investment growth. Of course, as values can fall, investments and income withdrawal levels need to be monitored.

As there's flexibility around when, and how much, income is taken under drawdown, clients can use this flexibility to take the funds tax efficiently.

Income drawdown has taken many forms over the years but there are currently two types of drawdown:

Flexi-access drawdown - This is the most common form of drawdown currently used. Any arrangements going into drawdown from 6 April 2015 will do so through flexi-access drawdown.

Those in flexi-access drawdown can take as much, or as little, as they want from their money purchase pension pot, when they want it - there are no income limits.

Those who take income under flexi-access drawdown will trigger the £10,000 money purchase annual allowance (MPAA) and unused annual allowance from earlier years cannot be carried forward for money purchase schemes. This could restrict future pension funding for anyone still potentially looking to carry on paying into their pension.

Capped drawdown - This is only available to those who went into in capped drawdown before 6 April 2015 and haven't converted to flexi-access drawdown.

There's a limit on the level of income that can be taken each year (see the 'Capped drawdown income limits and reviews' section) and so it's more restrictive than flexi-access drawdown. But capped drawdown does have major funding advantages over flexi-access drawdown:

• Taking income under capped drawdown does not trigger the £10,000 MPAA, and
• You can still carry forward unused annual allowance from the previous three years when calculating the maximum contributions to money purchase schemes

So capped drawdown can give an individual greater tax planning flexibility, if they're happy to take income (if any) within the capped drawdown limits.

But this funding advantage will rarely be relevant to those who've stopped working because, with no earnings, the tax relievable contributions they can make are less than the MPAA anyway.

Uncrystallised pension funds lump sum (UFPLS) is not a type of drawdown, but like flexi-access drawdown, it allows (in theory at least) clients to take as much or as little as they like from their pension as a lump sum. But it's not as flexible as flexi-access drawdown and it normally doesn't allow for situations where the tax-free cash entitlement differs from 25%. Taking a lump sum under UFPLS would also trigger the MPAA and the tax-free element is tested against the individual’s lump sum allowance (LSA) and lump sum and death benefit allowance (LSDBA).

Who can use income drawdown?

Firstly, it's important to understand that not all schemes offer the option of drawdown. Some clients may have to transfer if they want to access drawdown. And many pension providers will require a minimum fund size before letting someone set up a drawdown arrangement.

For the original member of a pension arrangement, drawdown can come into payment from the normal minimum pension age, currently age 55, or earlier on the grounds of ill-health.

But as well as being an option for members' own pensions, income drawdown can be used to provide pensions for beneficiaries - referred to as beneficiary's drawdown or inherited drawdown - on a member's death, even if they're under the normal minimum pension age.

And beneficiary's drawdown is no longer restricted to dependants. But it's only possible to pay pensions to individuals - so it won't, for example, be possible to pay a pension to a charity or a trust.

And it doesn't stop there. The pension funds can be passed on after subsequent deaths, allowing pension wealth to potentially cascade down the generations, whilst continuing to enjoy the tax benefits that the pension wrapper provides.

Suitability

Generally speaking, income drawdown is mainly suited to high net worth pensioners with larger pension funds who are looking for income flexibility, wealth preservation and ongoing active investment of their pension fund. In return, the pensioner must be prepared to accept a degree of investment risk and possibly variable income levels.

Drawdown arrangements need to be regularly reviewed to ensure investments are on track and that income levels are sustainable - especially where the client is reliant on the drawdown arrangement to provide an income for the rest of their life.

An option for some clients who require a certain level of guaranteed income could be to secure the guaranteed income by buying an annuity with part of their pension savings, or taking a scheme pension if they're a member of a DB scheme, and using any remaining money purchase funds for drawdown purposes. For DB members, this would require a partial transfer.

Unlike other retirement options, once you've chosen drawdown, you can change to a different option if you want - so it's possible to use all or part of the remaining funds to buy an annuity or, in theory at least, a scheme pension.

Capped drawdown income limits & reviews

Capped drawdown is a form of drawdown with a limit on the amount of income that can be taken each year.

Existing arrangements will continue to be subject to capped drawdown income limits unless the member converts the funds to flexi-access drawdown - this can be done by either by notifying the scheme that they want to convert, or by withdrawing more than the maximum capped drawdown amount.

It's also possible to crystallise new funds into capped drawdown, as long as they're under an arrangement that already has funds in capped drawdown. Whether this is an option will depend on the structure of the scheme - it's less likely to be an option under a multi-arrangement scheme as any new arrangements crystallised would be under flexi-access drawdown.

Income limit for capped drawdown

Under capped drawdown, a member can take an income of up to 150% of the basis amount* during a drawdown year. The first drawdown year started when the member designated some of their fund for income drawdown. A new drawdown year starts every 12 months thereafter.

* Calculating the basis amount - this is worked out using tables of rates provided by the Government Actuary's Department (GAD). The GAD tables are available on the HMRC website. The tables give a rate of income per £1,000 of drawdown fund, based on the individual's age and the current gilt yield (rounded down to the next 0.25%).

There are two GAD tables: one for those aged 23 or over and one for those under age 23.

If someone still in capped drawdown withdraws more than their capped drawdown income limit, their arrangement will convert to flexi-access drawdown and will no longer have any income limits. However, this will trigger the £10,000 MPAA (unless, of course, they've already triggered it - for example, under a different pension arrangement).

Beneficiaries in capped drawdown can exceed the income limits without triggering the MPAA - it's only triggered if they flexibly access their own pension funds.

Capped drawdown income reviews

The income limits for capped drawdown must be reviewed and recalculated regularly.

• Up to age 75: at least every three years
• After age 75: annually

Income limits and their review dates apply per arrangement, so schemes with more than one arrangement may have multiple income limit calculations and review dates.

This can be confusing when trying to keep track of the maximum income allowable in any particular 12 month period.

Unfortunately, it's not possible to change the drawdown year for an arrangement if the member is under age 75.

But pensioners aged 75 or over can align the drawdown years under various arrangements, by either shortening or extending the drawdown year under an arrangement. This can only be done once per arrangement and the scheme administrator doesn't have to agree to it.

If under 75, you can ask for an income review before your scheduled triennial review, but the scheme administrator doesn't have to agree it.

• You can only have an interim income review at the start of a drawdown year (they're not allowed mid-year)
• It has to be requested before the relevant drawdown year starts and
• The review starts a new three year review period

A review will also be triggered in the following situations:

• Part annuitisation - If you use part of your capped drawdown arrangement to buy a guaranteed income for life, the income limit for the remaining drawdown pension fund must be recalculated immediately. This new limit applies from the start of the next drawdown year. The reference period remains unchanged.
• Pension sharing order - If a capped drawdown arrangement is reduced as a result of a pension sharing order on divorce or dissolution of a civil partnership, the income limits for the remaining fund must be recalculated immediately. The new limits apply from the start of the next drawdown year. The reference period remains unchanged.
• Phased retirement - Some schemes have multiple arrangements. In this case, if the funds being newly phased into drawdown are in an arrangement which does not already have funds in capped drawdown, the new drawdown arrangement would be flexi-access drawdown.
  
  

  But if using a phased retirement approach within an arrangement that's already in capped drawdown, the arrangement can remain in capped drawdown:

  • The drawdown year and reference dates for all parts of the fund in drawdown under that arrangement are the same as those set for the first part of the fund used for drawdown.
  • But the income limits for the whole drawdown fund under the arrangement must be recalculated immediately every time you move another part of your uncrystallised pension fund into capped drawdown under the arrangement.
  • In these circumstances, the new income limit takes immediate effect and replaces the previous limit for the current pension year and the remainder of the review period. But if the new income limit is lower than the existing one, it doesn't have to start until the beginning of the next drawdown year.

Drawdown transfers

Drawdown funds can be transferred (whether flexi-access drawdown or capped drawdown) and there's no restriction on when, or how often, 'drawdown to drawdown' transfers can be made. This doesn't just apply to the original member - beneficiaries can also transfer drawdown funds that they've inherited.

However, it's not possible to partially transfer drawdown funds under an arrangement - all drawdown funds under the arrangement must be transferred. If there are multiple drawdown arrangements under a scheme, they don't all have to be transferred.

Any transferred drawdown funds must be ring-fenced and held separately from any other funds the pensioner has under the receiving scheme.

Capped drawdown transfers

Capped drawdown funds can be transferred and remain as capped drawdown funds in the receiving scheme.

The transfer does not impact on the income limits or the review period.

Transfers in drawdown when below age 55

Anyone under age 55 who relied on a protected low pension age to access their benefits can transfer their drawdown funds and continue taking income before age 55.

But care needs to be taken for such transfers that took place before 6 April 2015. The member could face unauthorised payment tax charges if they continue taking income before age 55, unless the transfer was part of a block transfer - two or more members of a scheme transferring at the same time to the same scheme - or was transferred to another scheme with a protected low pension age.