5 Things to consider before taking Income Drawdown

Posted By: Phil Handley DipPFS AwPETR On July 11, 2016 Category: Drawdown tips

What are your ongoing costs in drawdown?

Many providers offer income drawdown, but their charging structures are often difficult to understand.

Ask for an illustration from a number of providers using the same fund, for example Stan Life Managed or Aviva Mixed Investment (40-85% Shares). This will show you a like for like comparison on provider costs.

Usually, there are two or three ongoing costs involved.

  • The providers/platform/plan costs – this is the cost levied by the company administering the plan. E.g. Aviva, Scottish Widows, James Hay, Fidelity etc.
  • The fund management charges – this is the costs for the individual funds you hold within your plan. For example you might hold L&G, Gartmore and Schroders fund. These will have their individual management costs, ranging from 0.1% to 3%.
  • Adviser costs – if you are taking financial advice, there is usually a charge for your financial adviser to manage your plan in accordance with your risk level. It is also their role to ensure your drawdown plan is sustainable based on the income you’re withdrawing.

Ask for the above costs to be expressed as an overall percentage, that way you can judge who is cheapest.

A word of caution however, cheapest if not alway best. Think what you want from your provider and then choose one that offers those benefits. Common options people want are:

  • free fund switches
  • online access
  • no exit charges
  • low set up costs
  • financial stability
  • good administration

Income requirements

How much income do you intend on taking each year from your pension drawdown plan?

Is this realistic based on how old you are, the level of risk you’re taking and your expenditure needs?

You need to factor in other incomes you may be getting in retirement such as the state pension or any property income. If this is the sole income you’re relying on it needs to last.

There are a few online calculators to use to help manage expected income requirement with fund growth rates factored in.

It’s often a good idea to create a budget planner noting all you fixed outgoings such as bills, food together with less essential items such as eating out and holidays. You can then determine what you need to live and potential areas you can cut back on if your drawdown plan has a negative performance year.

Portfolio selection

Probably the most important decision is where your pension fund is going to be invested.

It vital you take advice in this area if you have little experience. Some providers offer a non-advised service and others have in-house advisers.

As a basic premise your portfolio should be diversified. The risk should be spread through different geographical regions, different sectors and different asset classes such as equity, bond gilts and cash.

It’s important to have a group of investment which match your expected volatility spectrum. If you can only afford for your fund to go down 5%, there is no use choosing a high-risk portfolio. Risk and return are related, therefore those who chase higher gains have to be prepared for higher losses also.

Your financial adviser should be able to help you assess your risk appetite and then recommend an appropriate portfolio of investments.

If you are investing yourself, you could use some of the data on funds from site such as Trustnet.

Understanding your tax position

Any income taken from a pension drawdown plan, after any tax-free cash has been paid, will be chargeable against your income tax liability at the following rates.

Income Tax Band Your income Income Tax rate
your personal allowance * Up to £11,000 0%
Basic Rate £11,001 – £43,000 20%
Higher Rate £43,001 – £150,000 40%
Additional Rate Over £150,000 45%

One of the unforeseen Implications of allowing full, unrestricted access is that HMRC can heavily tax large withdrawals. As the payments out of a pension scheme are processed much the same as PAYE, a large payment in one month could trigger a higher rate tax charge.

If for example £20,000 is taken as a one-off lump sum in April, HMRC don’t know that you’re not going to take the same level of income for the rest of the year, and therefore tax you accordingly. They would view this level of income as £240,000 per year (£20,000 x 12 months).

If you don’t intend to take any more pension income other than a one-off lump sum you can apply for the tax back using one of HMRC’s newly created forms.

Who to leave it to when you die

Money in income drawdown can now be left to whomever you choose, without facing additional tax charges.

Previously if funds were left to anyone other than your spouse/partner it could have been taxed up to 55%. This was abolished as part of the pension reforms.

An added bonus is that funds that are held within a pension on death, are not considered part of the estate for inheritance tax purposes. This allows pensions to be passed from generation to generation, similarly to the benefits of a family trust.

The rules allow for pensions to be passed on without any tax liability if the death of the member is before age 75. This could be spouse/partner, children or anyone other none family member.

If the member dies after age 75, the funds are taxed in the hand of the person who withdraws it. It’s simply added to their income tax liability in the year they withdraw an income. Therefore, if the beneficiary has a basic rate tax income, with £10,000 allowance before they breached the higher rate tax threshold, it would be prudent to withdraw a maximum of £10,000 from the inherited pension drawdown plan each year.