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.
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.
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.