Drawdown – What to consider

Advantages of Drawdown

  • You are able to take the maximum tax-free cash lump sum immediately to spend or invest without having to convert the rest of the fund to an annuity.
  • Under new Flexi Access Drawdown, there is no cap on the amount of income that can be drawn.
  • Flexible Income – you may choose to take any level of income, whether regular income or on an ad hoc basis, although income tax will be payable.
  • You can plan in advance the level of income that you wish to take each year so that you can take into account other sources of income that may be available to you.
  • The pension fund (less any income withdrawn and associated charges) will continue to be invested in a tax-efficient environment until you decide to purchase an annuity or continue drawdown.
  • You can structure your income to mitigate your liability to Income Tax. For example, by reducing drawdown income in some tax years, you may be able to avoid a higher rate tax liability.
  • You may be able to use income drawdown as part of your Inheritance Tax planning by taking varying levels of income, within prescribed limits, and using all or part of that income to make gifts to take advantage of annual exemptions.
  • There are flexible options on death. The death benefits payable may be greater than under the conventional annuity route, particularly since the death tax charge was removed.
  • As you get older there is the prospect of annuity rates rising and therefore providing a higher income. This is because it is cheaper for insurance companies to purchase an annuity to provide a given level of income for someone aged, say 70, than someone aged 60.

 

Disadvantages of Drawdown

  • An investment portfolio needs to be drawn up which will involve investment risk and reliance upon investment management.
  • A level of growth must be achieved by the pension fund in drawdown in order to maintain its value after the income payments have been taken (assuming an income is taken of course). If this is not achieved the fund may be unable to purchase an annuity equivalent to that which could have been purchased at the outset if income withdrawals had not been selected.
  • You may require a higher income from the plan than initially anticipated. It may not be possible to arrange an increase depending on investment returns.
  • Any investment returns may be less than those shown in the illustrations.
  • Should a high level of income be taken, unless there is exceptional growth the withdrawals will not be sustainable during the deferral period. This is particularly likely if maximum withdrawals are taken.
  • Deferment of the purchase of an annuity may result in less favourable annuity rates if and when a purchase is eventually made.
  • In addition, the investment fund may be depleted, either through investment performance or withdrawals, to the extent that even if current annuity rates are maintained, the annuity that can be purchased in the future will drop.
  • All income payments are liable to income tax at your highest marginal rate, although it is possible under drawdown to defer any income payments, which may be surplus to requirements.
  • Increased flexibility brings increased costs and the need to review arrangements on an on-going basis.
  • You may feel that the prospect of future higher income does not compensate you for being able to enjoy a guaranteed and secure level of income today and for the rest of your life.
  • Annuity providers make a profit from the fact that some individuals die sooner than is expected and use some of this ‘mortality profit’ to enhance current annuity rates. By delaying the purchase of your annuity, the benefit of this potential profit, which can be significant, may be lost.
  • In the case of death after age 75 the beneficiary will pay tax on the funds at their marginal rate of income tax. If the beneficiary does not have one, e.g. a trust or company, then the rate of 45% will apply.

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