Category : Drawdown tips

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.

 

 

18 Drawdown terms you should know about

Posted By: Phil Handley DipPFS AwPETR On April 28, 2016 Category: Drawdown tips

AMC – Annual Management Charge

The headline rate, levied by the fund manager which is taken from the fund annually.

TER – Total Expense Ratio

Describes all the charges associated with a product.

OCF – Ongoing charges figure

Describes all the charges associated with a product but includes performance fees and one of charges. Be careful when looking at the ongoing costs of running a fund as the OCF will often be higher than the headline AMC. Telegraph

SIPP

Many Drawdown scheme are provided through a SIPP or self-invested personal pension. These are tax efficient ways to hold your pension funds. They offer access to a wide range of investments from traditional funds, individual company share and commercial property to more diverse options such as Exchange Traded Funds (ETFs). They are a bit of a one stop shop, as they can hold a wide range of investments, unlike some provider in-house drawdown schemes (which can only hold their own funds).

Diversification

Most people entering drawdown will look to diversify their portfolios. This means not having all their eggs in one basket. When investing, the safer strategy would be to spread funds around in;

  • geographical regions of the world
  • different sectors (Pharmaceuticals, manufacturing, utilities, oil & gas etc)
  • Asset classes (shares, property, bonds, cash)

Investing in this manner, may not provide the best opportunity for maximum growth, however it will reduce downside risk to capital.

Model Portfolio

Some providers offer Model Portfolios, which are constructed to target a certain risk level. There are generally 10 risk levels, 10 being high and 1 being low. Some providers offer pre-constructed portfolios, which are aligned to these risk levels. The aim is to take the burden of choosing funds away from the investor. They will also keep a closer eye on the fund and any changing political or market forces, which may require a change to where the fund is invested.

Model portfolios are also offered by financial advisers.

Consolidating pensions into one fund.

I often get asked if it’s possible to move a number of pension schemes into one, before entering drawdown. There seems to be some myth that’s it’s not possible to do so. It can, and it’s the most popular way people amalgamate their pensions.

Emergency tax on large withdrawals

A complication of the pension reforms is the tax paid on large withdrawals from drawdown. Regular withdrawals are taxed at source and correctly, as HMRC know how much income will be withdrawn in one tax year.

Withdrawing large, one off lump sums however can be complicated. The revenue will treat a large one off payment as an expected future monthly income. Therefore, if £10,000 is withdraw in May with 11 month remaining of the tax year, HMRC would calculate the tax against an expected £110,000 annual income. Not ideal, but the tax can either be claimed back through various HMRC forms, or will be repaid at the end of the tax year.

Flexi-access drawdown, Pension Drawdown, Income Drawdown

They’re all the same thing, just different names used by providers/advisers.

Death Benefits

If you die before age 75, your estate gets to spend your remaining drawdown funds without any tax liability, if you die after 75, they’ll be taxed on the withdrawals against their own income tax bill.

Payment frequency

You can have your income whenever you want once in drawdown. It can be set up to pay regularly on a monthly, quarterly, bi-annual or annual basis. One of amounts can also be withdrawn without restriction (it will usually take around 20 days from the request to get paid however).

Discretionary Fund Management (DFM)

Traditionally, access to DFM’s were only for those with around £500 thousand and upwards, who wanted a personalised investment portfolio where the manager had discretion to pick any investments without the clients pre-approval.  The advantage being decisions can be made quickly to the benefit to the fund. Today however, pension freedoms have now allowed access to DFM’s in the mass market (with lower value funds) through the use of model portfolios. These are pre-constructed groups of investment which meet certain risk tolerance levels.

There are additional charges to involve a DFM, but the model portfolio option can be used for as little as 0.2% with some providers.

Initial and ongoing adviser charge

If you arrange a drawdown plan through a financial adviser, they will usually mention two charges. The initial charge covers the advice, research, recommendation and administration of setting up the plan.

The ongoing advice charge is usually a percentage, taken from the fund on an ongoing basis. This covers any administration throughout the year, but also includes an annual review. This should be a assessment of your current situation annually, discussion about fund performance, risk tolerance and any alternate recommendation which my become more suitable.

Critical Yield A

This is often mentioned in drawdown illustrations and leads to the most confusion with my clients when they first view them. Critical yield A, is the percentage by which a fund needs to grow, to provide (and maintain) a similar level of income, that could be achieve by purchasing an annuity.

Fund Risk

Investment funds are often categorised into various risk levels. This is to provide the investor, a snapshot of the potential volatility within the fund.

A financial adviser uses various tools to assess the investment risk of their client, however there are serval tools also available to the DIY investor.

It’s important to understand how volatile your investment may be and your tolerance for capital loss. Understanding what your investments might do, shouldn’t lead to panic selling if they go down. You have to be prepared to accept some losses in the short term in order to seek out long term gains.

Guaranteed Drawdown

Promoted as having the flexibility of drawdown with the guarantee of an annuity, guaranteed drawdown is trying to fill a perceived product gap.

You can have a guaranteed lifetime income through these product, only if you accept the income they are offering, which might be less than you need, and certainly less than you could get if you buy an annuity outright. You effectively trade this off, to keep full access to your pension fund if you need it.

You also pay higher annual fund and product charges than traditional funds.

Financial Service Compensation scheme limits

In income drawdown it’s £50,000 per investment institution. If you have £150,000 in three £50,000 funds with Aegon, and Aegon fail, you only have £50,000 protection.

If you have £150,000 in a funds with three separate funds managers, Fidelity, Standard Life and Prudential for example, your full £150,000 is protected. Short lesson here, diversify your investment.

If you hold any money on the drawdown providers cash account, this is covered under deposit protection up to £75,000.

Uncrystallised Funds Pension Lump Sums (UFPLS)

A method of withdrawing pension funds, announced by George Osborne along with flexi-access drawdown, but largely shunned by providers who either didn’t chose to offer it or offered it with restrictions such as 2 withdrawals a year or minimum £5,000 at a time.

 

 

 

 

Alternative tax-free cash options for your pension

Posted By: Phil Handley DipPFS AwPETR On February 11, 2016 Category: Drawdown tips Tax-free cash

If you’re looking to retire in the next few months and had your sights set on drawdown, you might be panicking with current market conditions. Your fund will have inevitably gone down and depending on how you were invested, this may be significant.

If you need to take an income from your pension to replace your salary, you’re going to have to make a choice where to put your money.

Whether this be an annuity or income drawdown, the tax-free cash figure you calculated a few months ago is likely to be less when you make your choice.

Being forced to take less tax-free cash just because you need an income is a bitter pill to swallow. Worry not, there are alternative ways to have access to your pension without locking in the lower tax-free cash.

I have recently suggested some alternative strategies to some of my clients which provides a chance for their tax-free cash to increase again.

The current school of thought by many is that when you want an income from drawdown, you crystallise (move your pension from the accumulation stage to the decumulation stage) all your pension in one go. It’s well know that at this point you can take 25% of your fund tax-free and the rest goes into a drawdown plan, which you can later draw an income from.

The downside to this is that you can only take your 25% once, and at the market value of your fund when you move it.

A little-known form of drawdown which was used before the pension reforms was called phased drawdown. Rather than move all your fund at once, you would take chunks as you need them.

How does this help?

Take this example.

Mr Smith and Mr Jones want to retire at 60 and have the same pension fund with the same value. They need £10k per year income after they retire.

Mr Smith has a fund of £125,000 6 months from retirement. On his retirement date, his fund is now only worth £100,000.

Mr Smith crystallises his £100,000 pension fund. He’s allowed 25% (£25,000) tax-free. £75,000 is then moved into drawdown which he can take further (taxable) income from.

Over the next 6 years until his state pension age he uses his £25,000 tax-free cash and a further £35,000 from his drawdown fund. As his income requirement is below the nil rate band for paying income tax (currently £10,600) he pays no tax during this time.

During this 6 year period his fund grows 4% per annum.

When his state pension starts, this uses up all his nil rate band meaning any further withdrawals from the crystallised drawdown will be subject to income tax.

He has no further tax-free cash to take and all his drawdown income is now taxable.

Full tfc drawdown

Mr Jones is in the same fund and retiring at the same time. He decides to use a phasing technique however.

Rather than take all his tax-free cash at the outset, he crystallises £10,000 (his income needs) per year.

£2500 of this is automatically tax-free however and the remaining £7500 is below his nil rate band, he also pays no further tax on his income.

At 66 his state pension starts and uses all his nil rate band meaning any further pension income will be taxable.

His fund has also grown by 4% per annum during this period.

Phasing drawdown

The difference with this method is that Mr Jones has further tax-free cash to take as he didn’t crystallise all his pension on day one.

In the above example Mr Smith has had £25,000 tax-free cash entitlement and Mr Jones will have £43,834 (6 x £2,500 plus the allowable £13,834 at the end) tax-free cash entitlement. They have both achieve the same income.

This above example might be presuming an ideal scenario but the concept is evident. Markets could equally decline leaving access to less tax free cash, however at least you are giving them time to recover.

There are two ways which this can be organised. Either finding a provider who offer a pension & drawdown in the same plan. This will allow easy movements from the uncrystallised to the crystallised part whenever income is needed.

The second method is by find a provider who offers Uncrystallised funds Pension Lump Sums (UFPLS).

It’s important to realise that there are alternative options in these depressed markets. Just make sure you’ve done your research before crystallising your fund as it can’t be reversed once the decision is made.

Not the best start for those entering drawdown

Posted By: Phil Handley DipPFS AwPETR On November 17, 2015 Category: Drawdown Fund Performance Drawdown tips Pension drawdown

The most overwhelming risk with income drawdown is running out of money before your time is up. Drawdown was only usually considered a viable option for those who could afford considerable fluctuations within their funds.  However, now it’s the default option for retirees.

One of the biggest fears is something called sequencing risk or ‘pound cost ravaging’. This is a result of early losses within the fund doing irreplaceable damage to the overall portfolio and strategy for sustainable income.

If a portfolio declines 10% and 5% income is taken during a year, it will need to grow by around 17.65% the following year to get back to the same position. It will need to grow by even more if income was taken in year two.

Take £100,000 declining 10%, which leaves £90,000 and then take 5% of the original value (£5,000). This leaves a fund of £85,000.

If the income needed was £5,000 a year (5% of the original value), any early losses means the fund would have to work a lot harder after these decline to be sustainable.

The perfect scenario is a fund which grows by 5% a year and the growth is just skimmed off the top, leaving the fund value constant.

So £100,000 grows 5% to £105,000, and 5% (£5,000) is taken. Meaning a capital value of £100,000 is left.

Unfortunately, markets don’t behave and right now, still within our first year of the mass take-up of drawdown, they’re being very naughty.

Markets are down 11.71% today, since the new tax year began on the 6th April.

What this means is that people who need to take an income at the above percentages, may have an issue with the longevity of their portfolio.

If the markets continued to decline for a second or third year at the same rate, it may force an earlier take up of equity release as an additional form of income.

Taking an income in declining markets locks in losses. It doesn’t give that part of the fund time to recover.  The result is a fund which diminishes a lot quick than forecast.

So what can you do to prevent this?

There are various schools of thought and strategies to limit this effect.

The 4% withdrawal rule is one commonly considered approach. Used largely in the US where people similarly keep their pension invested in retirement, it stated that you have an 80% to 90% chance that your savings will last 30 years. You simply withdraw 4% in the first year and then subsequently increase this by inflation to keep its real spending power.

This really depends on having a good diversifications of investments within your portfolio. Stocks, bonds, cash and property. Over exposure to less risky assets such as cash won’t provide it with enough ability to grow and over exposure to stocks might reduce its value significantly in highly volatile markets.

Another key consideration is life expectancy. How long will you need the money to last? This is the $64,000 question. A clever way is to use annuity companies to help you.

Annuities are based on medical history and the insurance companies are pretty accurate at assessing risk. They will determine, based on your health, medication and past ailments, how long they will have to pay you before they make a profit.

You could therefore request a number of annuity quotes to determine what break-even point is. How long will an annuity company pay you before they have paid out more than you put in. Obviously they will factor in the growth you receive on your money but it’s a useful, if not sobering tool to use.

Others suggest keeping some of your drawdown fund in cash. This can be used instead of selling investments within your fund when markets are declining. It could then be replenished in rising markets after some growth is achieved.

A sensible, if not always practical route, is to only take the income generated by the investment, this is known as the natural yield. This would leave the underlying investment intact giving it more chance to provide the realistic growth you expect.

There are many options to consider and they won’t be suitable for everyone.

What we do know is that right now, those who have entered drawdown haven’t got off to a good start. If investment risk is something that’s new to you or your nervous of the effects it could have on your fund, there are other more secure options.

If in doubt discuss these with a financial adviser.

5 income drawdown strategy tips

Posted By: Phil Handley DipPFS AwPETR On May 17, 2015 Category: Drawdown tips Pension drawdown

If you opt for income drawdown in retirement as opposed to an annuity (guaranteed lifetime income), you’ll need to think carefully about your withdrawal strategy. You’re now at the point in your financial life when you’ve reached the peak of your savings journey. Until now you’ve been on the accumulation stage, amassing wealth, but now it’s time to start drawing down on the assets. The trick is to make the income you take last your full retirement and not run out before.

Savings and investment for retirement may have taken various forms. Pensions, ISA’s even a buy to let property. You net worth has climbed though out your working career but now it’s time to enjoy the fruits of your labour.

The new pension reforms have shifted the landscape with how people look to enjoy their savings. Annuities were straight forward. Hand your pension fund over to an insurance company and then receive a lifetime income. The improving life expectancy and depressed gilt rates have obliterated the value of these in recent year however. Income drawdown has become favourable because of the flexibility it offers. Having unrestricted access to your fund, giving it a chance to continue to grow by keeping it invested and importantly being able to pass any unused fund to your estate are major plus points. The downside however comes in its complexity.

Many people aren’t used to making investment decisions. Certainly with the largest savings pot they’ve probably amassed. The decisions made now will affect the rest of retirement. Here are 5 things to think about before jumping into income drawdown.

  1. Complete a risk profile. Your attitude to risk changes in retirement so it’s important to understand where your money is invested and what are the probable returns of your portfolio. Being ill informed about the volatility of a portfolio may lead to some nasty shocks which your financial situation may not be able to tolerate.

  2. Hold a cash reserve. Stock markets go both down as well as up. If you have all your savings in the markets and they take a dip, you’ll be pulling out units before they have chance to recover. Holding a cash pot which can be used in declining markets will provide some buffer to volatility. Gains in future years can be used to replace the cash reserve.

  3. Do a budget planner. Having an idea what your outgoings are is essential to making your income drawdown pot last. Think about spending now and how this may change in future years. Usually the need for income is more in the immediate years after retirement, it may lower in mid retirement but care home costs may bring this back up at the end. Research has suggested that taking 4% from a drawdown plan is a sensible way of providing some sustainability.

  4. Understand income tax. Any money withdrawn after you take your tax free lump sum is added to your annual income tax allowance. Therefore if you take advantage of the unrestricted withdrawals and take a large amount, this may be taxed at a higher rate initially. HMRC will treat the payment as a potential monthly payment rather than a one off lump sum and tax it accordingly. Royal London have summarised how to reclaim this here.

  5. Review your portfolio regularly. Keep close to how your investment is doing. Where it’s invested, what the returns are and what affect your withdrawal are having on its sustainability. If you’re using a financial adviser they should be reviewing this at least annually with you. You attitude to risk may change, your financial needs or personal circumstances may change. Make sure your drawdown plan is doing what you expected it to and is complementing your retirement not reducing the quality of it.

If you want to research some of the top performing funds by sectors check out our fund sectors page.