What is Pension Drawdown?

Pension drawdown or flexible drawdown refers to withdrawing form or encashing a pension flexibly, rather than having to buy an annuity or scheme-based income for life.

Flexible drawdown has been available since 2015 and refers to either defined contribution / money purchase type plans.  It allows withdrawals of money (from the pension itself) as the client may see fit in a combination of lump sums or regular income. 

To allow or enter drawdown, the rules are actually straight forward:

• You must have reached the legal minimum pension age (currently 55/57 from 2028) – or meet the definition for ill-health retirement if earlier.

• Your existing provider should allow you to use flexible drawdown (if not, you will need to transfer out to benefit).

However, that is where the simplicity ends.  Many providers either will not allow or cannot cope with providing drawdown.  In this example, you would need to transfer your plan into one that will allow the flexibility being sought.

How Pension Drawdown is Taxed (Including Tax-Free Cash)

Essentially you can Essentially you can take 2 types of payment form your pension as follows:

• Up to 25% tax-free

• The remaining being subject to income tax as earned income

Many clients believe that the tax-free cash (also known as pension commencement lump sum) has to be taken as a one-off payment but you would be wrong!  You can take any combination of tax-free cash and taxable income payments as you see fit.

To manage the flexible drawing of your benefits, we use the terms “crystallised” and “uncrystallised” to help us manage this.

Uncrystallised is how all pensions start.  Simply put, it is “money in a pension from which no tax-free cash has been taken”.

Crystallised is how money is classed after the tax-free cash has been taken from your fund.  Simply put, it is “the taxable money left in your pension after drawing your tax-free cash” – in other words the remaining 75%!

Explaining the word flexible

In a flexible drawdown arrangement, you no longer have to take any of your money in lump sums or regular payments but are free to increase, decrease, stop or start either lump sum or income payments as you see fit.  Obviously, the taxable income part is subject to tax at your highest rates!

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Here are some examples of different “drawdown strategies” all based on a client with £100,000 pension, over the age of 55 and never having drawn anything previously:

Lump sum example 1:

Tax-free cash                    £25,000 (as a lump sum)

Taxable income                £75,000 (as a lump sum)

In other words, encash the entire fund on day 1 although the £75,000 will be taxed heavily!

Lump sum example 2:

Tax-free cash                    £25,000 (as a lump sum)

Taxable income                £0

In other words, just take the full tax-free cash on day 1 and leave the rest (crystallised bit) until a later date (perhaps when you have some personal allowance available for example).

Lump sum example 3:

Tax-free cash                    £25,000 (as a lump sum)

Taxable income                £750 per month

In other words, just take the full tax-free cash on day 1 and then draw a taxable income from the remaining crystallised bit.  The £750 per month will then be taxed.

Income example 1:

Tax-free cash                    £250 per month (25%)

Taxable income                £750 per month (75%)

In other words, no lump sums at the beginning but the monthly withdrawals are then paid 25% tax-free and 75% taxable.  The remaining available tax-free cash and income pot should then (hopefully) grow meaning it may last longer!

Or any combination of the above, at any time you wish subject to the maximum of 25% tax-free on the uncrystallised bit!  You could even purchase an annuity with portions or the full fund whenever you like!

Other points to consider

• New capped drawdown plans are no longer allowed, however where one was in payment before 6/4/2015 it may remain in force.

• You can convert your remaining savings to an annuity at any time (but usually, not the other way round).

Still confused?  Contact your local experts for advice on all things pensions and guarantee your very own Financial Fortress!

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