An alternative to annuities, pension drawdown plans could offer greater flexibility, investment control and opportunity to grow your fund
Most people think that when it comes to receiving a pension you must buy an annuity. But there is another way. It’s called a pension drawdown plan. Like an annuity, it provides an income – but unlike an annuity, you still keep part of your pension fund invested. If managed correctly, that fund could continue to grow and eventually be left to your family.
Pension drawdown plans (now known as flexible or capped drawdown), allow individuals to take pension benefits from age 55 onwards, immediately and without buying an annuity.
Put simply, a pension drawdown plan is a personal pension plan from which you can draw an income while leaving the residual fund invested – and it can offer big advantages, according to Jonathan Walker, managing director of The Pension Drawdown Company.
Walker says: “Pension drawdown plans are an alternative to annuities. Drawdowns have been perceived by some as high-risk investments, but really the level of risk is based on the funds or assets that the client has agreed to invest in, which can range from very conservative to more adventurous, and the big advantage is that funds can be changed frequently to suit different investment conditions.”
Interest rates influence the rates paid by annuities. “The Bank of England’s base rate is at an all-time low, so if you can afford to wait, it may make sense to delay buying an annuity until the environment is more propitious,” says Walker.
Annuities carry other disadvantages, he explains. “Using an example of a £100,000 pension fund, and an annuity paying 5.9 per cent, after 25 per cent tax-free cash you would get an income of £4,425 for the rest of your life. But if you have a spouse who is younger than you, the joint annuity rate could fall to around 4.7 per cent.”
“Moreover, if inflation concerns lead you to index the annuity, that rate may fall to around 2.5 per cent, giving you £1,894 per annum. Finally, building in a capital guarantee to ensure that any undrawn capital is paid out to your estate – thus benefiting your children, for example –would reduce the annuity rate even further. The more flexibility you demand from an annuity, the poorer the rate is likely to be.”
“However,” he adds, “if you die and you have a pension drawdown plan, all of the pension fund capital will be passed on to your spouse, who can pass it on to children or other beneficiaries, subject to tax (currently 55 per cent). Many of our clients now realise their pension fund could be a legacy to their children that may be worth more than their residence.”
Tax-free lump sum
So how does drawdown work? Walker says: “You can immediately take a 25 per cent taxfree lump sum, amounting to £25,000 if you have a pension fund of £100,000. Compare this with a final salary scheme, where an income of £4,000 could mean you only received £12,000 tax-free cash.” (Individuals are allowed a tax-free lump sum often equivalent to only three years of income.)
“In the drawdown scheme, the remaining balance will generate an income, which is roughly the same as your single life annuity rate. In this case, the rate is 5.9 per cent, or £4,425.”
“Meanwhile you need to ensure that your remaining fund grows at a faster rate than you are taking the income out. So as well as receiving an annual income of up to £4,425, our aim as advisers would be to grow the residual fund, so that the income taken doesn’t start to erode the remaining invested amount.”
Moreover, some forms of drawdown have guarantees, where the fund value is ring-fenced annually and guaranteed to appreciate by at least three per cent. “So your investment will be protected if the stock market plummets just after your fund has passed a guarantee date,” says Walker.
“The amount of income you can receive also grows if the fund value of your plan rises. So if your residual fund was to increase to say, £150,000 from £75,000, the amount of income you receive, using the above example, will increase to £8,850 (5.9 per cent of £150,000) – though this, of course, is subject to future annuity rates.”
Walker points to the experience of a client, a lawyer based in Hampshire, who received a tax-free lump sum and is now getting the maximum income possible from his pension. With the ongoing help and advice from The Pension Drawdown Company, this client has still seen his fund increase from just over £99,000 to £119,000 within two years.
Mr Walker believes that proactive management and advice are essential. “We advise our clients to reduce exposure and risk as the market rises, so that the pension fund is protected when markets fall,” he says.
How Robin increased his nest egg
Former business development manager Robin Leat, 65, of Worthing, West Sussex, says: “After researching pension options I chose a drawdown scheme over an annuity, and it was arranged through The Pension Drawdown Company just over two years ago.”
So far his decision has paid off. Leat says: “Had I chosen to take out an annuity, the total income from the fund would have been about £10,000 to £11,000 maximum – significantly less than I have drawn down. Meanwhile, the fund has grown by more than 31 per cent since April 2009.”
The moral is simple, Walker concludes. “If you’re about to retire – don’t expect your pension provider to spell out your options. Talk to The Pension Drawdown Company to find out what they are, with a free consultation. We can also outline the risks and whether or not pension drawdown is suitable for you.”