With this option you take your 25% tax-free lump sum all at once. Then with the remainder you get a flexible income drawdown product.
What is a drawdown?
This is an investment product. So your money will be buying a mix of investments – shares, funds, gilts, corporate bonds or more. The aim is that your cash will continue to grow as if in a pension. You can also withdraw money if and when you need to.
As this is an investment product so there is an element of risk – your hope is it will grow, but there is a chance it will shrink as with many investment products including your pension they invest in the stock market which fluctuates.
Where is my money invested?
When you go into income drawdown, if your money has been invested in a personal pension or SIPP with the provider that you are going into income drawdown with, then you can keep the same investments, they can just be re-registered to the drawdown account without the need to sell and buy back.
However, you may want to use the opportunity to take a look at what investments you have and see if they are still suitable. You’re also able to move your investments to a different provider. This might be a good option if you’ve been charged a lot with your current provider and are looking to cut costs when you go into drawdown.
How do I drawdown my money?
Each pension provider will be different, but you will usually be sent an illustration of the drawdown account and application form to get things set up. Once it has received all your forms back you’ll be transferred the tax-free cash and the drawdown account will be set up. It could take a few working days to receive your tax-free cash.
Then in the future, any income that you want to receive from your drawdown product will usually go through the provider’s payroll system, so will be paid out on a designated day of the month.
What are the charges?
As well of the cost of investing within the drawdown product, you will normally have to pay an annual cost. This varies between different pension providers.
Below is a list of some of the most popular UK pension providers and their current charges.
Aegon – £75 per year
Aviva – £0
Bestinvest – £0
Fidelity – £0
Friends Life – £0
Hargreaves Lansdown – £0
Legal & General – One off £250 set up fee
Prudential – £0
Royal London – One off £186 set up fee
Scottish Widows – £0
Standard Life – £0
Zurich – £0
How much income should I take from my drawdown product?
As your money is invested when it’s in a drawdown product it will obviously fluctuate with the stock – there will be ups and downs, but hopefully on the ups you will make up the money that you lost on the downs.
But if you take money from your capital (the amount you have in drawdown) when you’re going through a dip, your money will have to work even harder to make up the shortfall.
Keep this in mind if you are thinking about taking money from your capital.
What is the tax situation?
The money you take will be added to any other income received in that tax year. So if you’re planning on taking large withdrawals it may push you up into a higher tax bracket. You could even become an additional-rate taxpayer and end up paying 45% tax when you take your money.
When you first take a taxable lump sum or income from a pension in drawdown, it is likely that emergency tax will be deducted, unless your retirement provider has been supplied with a P45.
If it is not provided with this, emergency tax will be deducted until HMRC sends your correct tax code directly to your pension provider. More tax may be deducted than you owe, in which case you will need to reclaim this from HMRC directly.
What happens when I die?
Going into drawdown means that you can leave any remaining money to your beneficiaries tax-free when you die. But there are a few considerations:
If you die before age 75
Your beneficiaries can take the whole pension fund as a lump sum or draw an income from it tax-free. Dependants (but not other beneficiaries) can also choose to buy an annuity, in which case the income will be taxed.
If you die after age 75
Your beneficiaries have three options:
Take the whole fund as cash in one go: If they choose this, the pension fund will be subject to 45% tax.
Take a regular income: If they choose this through income drawdown or an annuity (option only available to dependants), the income will be subject to income tax at your beneficiary’s or beneficiaries’ marginal rate.
Take periodical lump sums: If they choose this, the lump sum payments will be treated as income, so subject to income tax at your beneficiary’s or beneficiaries’ marginal rate.