Friday, October 28, 2011 | Posted by: Mike Hyland
Categories: Personal, Protecting your wealth | Tags: tax, tax planning, HNWIs, income tax, pensions, retirement, tax relief, Mike Hyland, minimise, high earners, higher rate taxpayer, pension, James Temperley, pension series, pensions changes, income drawdown, flexible drawdown, annuity, capped drawdown, 50% tax
A common reason clients give for not wishing to contribute to pensions are the restrictions on how and when they can access their pension benefits after retirement. From April this year there is a new option for such retirees. Flexible drawdown, as the name suggests, will give individuals much more freedom as to how they take their pension benefits.
What was wrong with annuities and pension drawdown?
Up until April 2011, individuals reaching retirement had two main options for their pension fund: use it to purchase an annuity (a guaranteed income for life) or, if they wish their funds to remain invested beyond retirement, enter income drawdown.
An annuity pays a fixed or rising regular income for the remainder of the individual’s life (and possibly beyond). Income drawdown is more flexible in that the individual can choose how much income they wish to receive each year, although this is still subject to a cap at roughly the same income level as an annuity would provide.
Neither of these options allow for a significant proportion of the pension fund to be withdrawn at any one time.
What has changed?
Individuals who qualify for flexible drawdown are able to draw unlimited amounts from their pension fund. This means that the entire fund could be withdrawn over the course of a year or two if desired.
While clearly this will not be appropriate for many – not least because of the high potential tax rate if all of the income is lumped into one or two tax years – it does make your pension options much more flexible and means that income levels can be adapted to suit the peaks and troughs of your personal expenditure. Furthermore, it facilitates some interesting inheritance tax planning opportunities.
How am I taxed?
Individuals choosing flexible drawdown will be able to take a tax-free lump sum of 25% of their fund, subject to the normal pension rules. Thereafter, all funds withdrawn from the pension fund will be taxed as pension income (ie the same as an annuity or under income drawdown).
Do I qualify?
Since the Government is keen for us to be prudent with respect to our retirement, you will find it unsurprising that you have to meet several conditions before you’ll be allowed the possibility of withdrawing all of your fund in one fell swoop.
The major requirement is that you must have secured pension income of £20,000 a year, not including potential income from the pension fund which you wish to enter flexible drawdown. This could be from any combination of occupational pensions (broadly you are allowed to count income from schemes where there are more than 20 members), pension lifetime annuities and state pensions. In addition, no further contributions can be made by you, or on your behalf, to a defined contribution scheme in the tax year in which a flexible drawdown payment is taken, and you must no longer be accruing benefits under any final salary schemes.
The bottom line
While flexible drawdown is not for everyone, it is a welcome additional option for many individuals. We would recommend that advice is taken in deciding whether flexible drawdown is for you and in planning for future income withdrawals to ensure that these are as tax efficient as possible and that your pension fund lasts as long as you wish it to.
Pension planning series written by Mike Hyland, Assistant Tax Manager, and James Temperley, Chartered Financial Planner.
Image: © Danielle Scott
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