Benefits and Risks of Pension Drawdown
April 22nd, 2015
Benefits
- It’s a more flexible retirement option, individuals can carry on working and use pension drawdown to top up their income. Income can be varied to meet an individuals need e.g. if hours are reduced at work pension income can be increased.
- Individuals can take out as much income as they require with Flexi-access drawdown, including taking maximum 25% tax free cash and taking no additional income.
- Building on this further individuals could use a combination of taxable and tax free cash to take income in a more tax efficient manner.
- With many drawdown providers there are a large selection of investment options that funds can be invested in.
- Due to the flexibility of drawdown an individual would not be locked in for life, like with a lifetime annuity. At any state a different method of providing retirement income can be switched to e.g. in the event of ill health an individual could switch to an enhanced annuity.
- Individuals can chose to leave their remaining pension funds to any person, trust or charity. This could be taxable if over are 75 upon death.
Risks
- The value of a pension can go down as well as up, potentially falling below the amount invested. This means income will not be guaranteed and could vary over time.
- An individual’s pension needs to grow to compensate for the income they withdraw. If that doesn’t happen the income they take will deplete their pension fund, especially if a high level of income is taken.
- The Selection of appropriate pension funds to invest in is crucial, it would be recommended that only those with a high degree of knowledge and experience chose their own investment funds. Those who do not, are advised to seek professional advice.
- There is no guarantee that should an individual switch to an annuity to generate income in the future that rates will improve from their current low levels, and may fall.
- If an individual starts income drawdown and continues to contribute to a money purchase pension, their annual allowance will fall from £40,000 to £10,000. (The annual allowance is the limit that individuals will receive tax relief on their contributions)
- Should an individual chose to strip all of their pension assets in one go, it’s likely that they will receive a tax bill. The balance of pension after tax free cash is treated as earned income in that tax year. E.g. an individual earns £30k in a year and encashes a £50k pension after tax free cash in the same tax year. They will be taxed as if they have earned £80k and taxed at the higher 40% rate.