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Understanding income drawdown

30 April 2018

Never in the history of pensions has so much confusion been caused to so many by so few words in a Budget speech!

It is now over four years since George Osborne dropped his ‘pension freedoms’ bombshell but many employees still have little idea exactly what this new flexibility involves.

Some in defined contribution schemes may vaguely be intending to indulge in ‘income drawdown’ at or before their intended retirement date rather than purchase an annuity. But they may not have a clue how to actually set about doing so.

However, it is very much in their employer’s interests to enlighten them by laying on generic financial education seminars and workshops and, if they feel they can afford it, offering access to one-to-one personal financial planning advice. Chase de Vere can help in both respects. 

After all, if employees get their retirement planning wrong it will not necessarily just be them and their families that suffer. It can play havoc with their employer’s succession planning If they end up having to work for longer than they had originally intended.

Some of the confusion around income drawdown – which allows you to make withdrawals whilst your fund remains fully invested – is caused by the fact that it was permitted on a more restricted capped basis before the new pension freedoms were introduced in April 2015.

Those who used it under the old regime needed to purchase a distinct product for the purpose whereas now those aged 55 or over can in theory just take what they like when they like from their existing pension pot in much the same way that they can access a bank or building society account.  

But the words “in theory” cannot be emphasised strongly enough because there remains a massive difference between what the pension freedoms regulations permit and what the market actually makes available.

In practice few pension schemes currently allow you to dip in and out as you please. The vast majority of personal pensions and group personal pension schemes still require those wishing to do so to buy a separate income drawdown product.

This will normally be much easier to set up than an old-style income drawdown product. Indeed, it may amount to little more than a technicality. Nevertheless, it might involve paying higher charges.

It is also possible that the income drawdown product being offered by the employee’s pension provider does not offer the most appropriate bells and whistles for the individual concerned.   

Those wishing to do income drawdown should therefore consider what is available from the entire market rather than just from their current pension provider, and the Financial Conduct Authority (FCA) has been expressing concerns about the lack of people doing so.

Because there is such a bewildering array of options on offer, those shopping around the market really need to be doing so in conjunction with one-to-one personal financial planning advice.

Such personalised advice can also prevent them both from running out of funds in their pension by underestimating how long they will live for and from incurring unwanted tax bills.

Although 25% of one’s pension pot can be accessed as a tax-free lump sum, further withdrawals – although not subject to any limit – are liable to Income Tax at one’s highest marginal rate. 

If therefore the amount withdrawn raises one’s total annual income into the higher-rate tax bracket the withdrawal will incur higher-rate tax, and some people have unwittingly incurred huge tax bills whilst taking out lump sums.

The FCA has concerns over the number of employees who are entering income drawdown without taking appropriate advice, and employers should think carefully about whether they can afford to fund this –  or at least offer to split the costs with employees. 

Those who feel they can’t afford to can still assist employees by referring them to a suitable independent financial adviser (IFA). Chase de Vere is well placed to help because, unlike many of our competitors in the employee benefits space, we have an IFA arm.

If you would like to know more about how we can offer your employees personal financial planning advice or generic educational programmes that explain income drawdown then please do not hesitate to contact us on 0345 300 6256 or complete this simple form and we’ll call you.