What has changed?
Investors now have the freedom to take as much as they like from their pension fund at retirement. The days of an annuity as the only option for a member of a Defined Contribution (DC) pension scheme are a distant memory and investors are looking at the drawdown facility from their pension as a way of exercising greater control of and receiving better returns from their pension in retirement.
Drawdown offers the opportunity to take up to 25% of your pension as a tax-free lump sum up front, as well as the potential for growth through investing as well as providing an income in retirement. It also enables you to create a legacy and pass on your pension fund. For many people this control and flexibility gives drawdown its appeal.
What is the Annuity option?
This was the traditional option for many retirees with a defined contribution pension scheme. What this basically offered was a certain income for life in exchange for the pension fund.
When an individual died the income ceased, unless an agreement to continue a reduced payment to a spouse or dependents had been agreed at outset, in which case the initial payments to the member would also have been reduced at outset in lieu of this “benefit”. Many people did not even look at the open market option which gave investors the opportunity to search for the best annuity deal rather than the one offered by the provider with which they held their pension, resulting in some very poor incomes for members.
Below are the best and worst examples of a 2017 annuity for a 55 year old with a £100,000 pension fund on a single life basis.
Level income for life: £4189 per annum (Best)
Level Income for life: £3630 per annum (Worst)
Income for life increasing at 3% per annum: Starting £2588 per annum.
It is important to note that on a single life basis when the investor dies the income will cease and the fund will revert to the institution that provided the annuity.
What is the Drawdown option?
Below is an example of the income option available using the 25% tax free allowance over a 5 year term. As you will see, even after taking a larger income than the best annuity example above there is still growth in the capital fund.
Property Bond – £100k invested: 10% per annum growth
Year 1 – £100,000 in pension fund – 10% growth – £110,000 in pension fund – Income – £5k
Year 2 – £105,000 in pension fund – 10% growth – £115,500 in pension fund – Income – £5K
Year 3 – £110,500 in pension fund – 10% growth – £121,550 in pension fund – Income – £5K
Year 4 – £116,550 in pension fund – 10% growth – £128,205 in pension fund – Income – £5K
Year 5 – £123,205 in pension fund – 10% growth – £135,525 in pension fund – Income – £5K
£25,000 income over a 5 year term and an increase to £130,525 in the pension fund achieved from a property based investment with the security of a 1st legal charge over physical property.
What is the tax position?
Under flexible pension rules, you can decide whether you take your full 25% tax free amount up-front, in which case the remaining 75% will be treated as taxable income when this option is taken, you can take 25% as tax free income over a given term (as detailed above) or take staged payments which are a mix of tax free cash and taxable income (in which case, 25% of each payment will be tax free and the other 75% will be taxable) Tax is taken using the PAYE system salary. How your pension payments are taxed depends on whether you decide to take part or all of your fund, you have other PAYE income and you receive the state pension.
Drawdown Advantages:
Control of investment.
Potential for capital growth of fund in addition to an income.
Individual’s beneficiaries can continue drawdown on death of member saving on income and inheritance tax.
Flexibility on income choices. With an annuity you have to choose all your options at the start.
Drawdown Disadvantages:
Future investment returns are not guaranteed
Income Drawdown is a higher risk approach to pension income withdrawal than an annuity as it is reliant on an individual ensuring they do not overdraw.
Summary
If you are looking for a way that you can achieve greater income from your pension fund, where you can grow the size of the fund while receiving this and create a legacy for your family then there is an opportunity for you to do so.
If you’d like to find out more about how The Landlords Pension could help you grow you
