Unsecured Pension (Income Drawdown / Fund Withdrawal)
Unsecured Pension is an important option to consider when you are approaching retirement.
Income drawdown plans came about following changes to the law in 1995. Pension simplification (A-Day) came into being in April 2006 and further enhanced the income options available. With these changes came a change of name to “Unsecured Pension”.
The requirement to buy an annuity as soon as you retired has not existed for some time, instead, Unsecured Pension (USP) allows you to start taking an income directly from the pension fund itself.
This gives you the flexibility to retain your “pension pot” and keep the funds invested, allowing you to defer the purchase of an annuity to a time that better suits you. Most of the major insurance companies now offer drawdown plans for pension funds in excess of £100,000.
At the time you wish to draw benefits you will have two options:
· Take part of the fund as a tax-free cash “pension commencement lump sum” (usually 25% but can vary) & invest the rest into an annuity – to your specified requirements.
· Take part of the fund as a tax-free cash “pension commencement lump sum” (usually 25% but can vary) & draw an income from the rest of the fund instead of buying an annuity.
If you choose to take the withdrawals the limits are determined by the Government Actuaries Department (GAD) and can be between £0 and 120% of the GAD rate – which is roughly in line with a single life annuity rate. You can stop withdrawals at any time, and use the remaining fund to purchase an annuity.
Income limits must be reviewed at least every 5 years and are based on age, gender, fund size and the GAD rate (which is in turn based on the gilt rate at the time).
At age 75 you can either purchase an annuity or switch into “Alternatively Secured Income”. This is a limited form of Unsecured Pension where the fund is retained and an income is drawn from it. However minimum and maximum limits are imposed. Income is reviewed annually and is based on gender, fund size and the GAD rate for a 75 year old (regardless of age).
Like phased retirement plans, income drawdown plans carry heavier management charges than ordinary policies, as a result they are also only really suitable for larger funds.
Advantages
Like phased retirement, pension fund withdrawal gives you control over when you commit your pension fund to an annuity. This can be an advantage if rates are particularly low when you come to retire. In addition, annuity rates improve in relation to age, so the older you get, the better your annuity rate could be.
Within certain limits, you have the flexibility to adjust your annual income to levels that suit you. All the while, the fund could continue to benefit from potential investment growth. If these are favourable, & your income withdrawals are not too high, your fund could even continue to grow until you finally purchase an annuity. In other words it may be possible to take an income & still see your pension fund rise in value.
With pension fund withdrawal there are several options on death:
· Your spouse/dependents can “step into your shoes”, continuing to draw an income from the fund
· Your spouse/dependants can use the fund to purchase an annuity in their own name
· The remaining pension fund could be paid to beneficiary(ies) less a 35% tax charge
If you do not need to depend on a secure income (especially in the early years), require a flexibility and/or you have a spouse/dependents income drawdown could well be suitable.
Disadvantages
Like phased retirement, pension fund withdrawal does not guarantee better annuity rates in the future. There is always the risk that annuity rates will worsen in the future, which will of course result in lower income. Furthermore if income withdrawals are high the problem is exacerbated.
The same is true of the remaining pension fund. Whilst drawing income, the fund itself is susceptible to the rises & falls of their underlying investments. This could result in your fund shrinking which would obviously affect the annuity income you could buy. Even if investment performance is only poor for a few years, it could have a significant effect on your eventual pension income.
High withdrawals combined with poor investment performance are the biggest risks involved. For this reason, pension fund withdrawal is usually only suitable for people who either can afford to take a reasonably conservative income, have other sources of income or fully understand the risks of capital erosion.
Although individual advice and circumstances will determine the suitability of an Unsecured Pension, in simple times, if the income withdrawn plus charges, is more than the growth enjoyed by the underlying pension fund then capital erosion will take place and it is likely that this will lead to a proportionate reduction in future income.
The costs associated with Unsecured Pension Funds can be higher than those of an annuity.