If your reading this then chances are you are approaching retirement, and have built up pension funds throughout your working life. The most common route to converting your fund into an income is via an annuity.
Whilst an annuity will provide you with a secure income in retirement, income drawdown offers the complete opposite. An income that is unsecured. This means that throughout retirement your income can go up, and down in value, or even cease to be.
What is income drawdown?
When you choose income drawdown to provide your income in retirement, you retain control of your pension fund. You can take up 25% of your fund tax free and the rest of the fund provides an income taxable at your marginal rate.. At present you are able to withdraw a capped amount of income from your fund. This amount is set by Government. However, from April 2015, it was announced that this cap will be removed, and people will have complete access and control of their pension fund.
Unlike an annuity, it will be your responsibility to make your pension pot last you throughout your life. A certain level of investment return is required to receive the same amount of income from income drawdown, as you would from an annuity. If the investment returns are not sufficient, the income from an income drawdown plan could be lower than from an annuity and in extreme situations, your fund could become completely exhausted.
Risk: Investment Returns
From single life annuity you would have to survive 17 years to have received your pension fund back into your estate. The longer you live the more profit you have made. Via income drawdown if you are risk averse and prefer safer assets such as cash deposits, then likewise your pot will run out in approximately 17 years. This assumes charges negate any low interest received.
An element of investment risk needs to be taken to produce a return, to maintain that level of income throughout retirement. If the return is not sufficient, either a smaller income has to be taken, or you would run out of money.
Volatility is the amount your portfolio can fluctuate in value. Higher risk portfolios will rise and fall more dramatically over a shorter period of time than lower risk portfolios. Whilst this can sometimes be beneficial when building your portfolio as it can present money making opportunities by ‘buying low’ and ‘selling high’, when in income drawdown, it can mean having to sell off more units (pieces of your pension) to maintain your income resulting in the value of the fund depleting more quickly. This can make it difficult to make up the losses, particularly in a falling market. Ultimately it could mean that your fund runs out much sooner, even if the required return is achieved.
It is important to invest in the right asset mix and regularly review the plan to stand the best chance of maintaining its value in future.
Income drawdown can be extremely flexible, and the death benefits can be attractive. Especially considering a 65 year old would be 82 before they benefit from an annuity, and if they die sooner their capital is lost (unless death benefits are selected). For those people however that require a guaranteed income for life, an income drawdown plan is not a suitable option. The pot can be left in full to a spouse as an income drawdown, or left as a lump sum minus 55% tax.
Income drawdown also allows you to vary income payments to suit your changing circumstances throughout retirement. It also allows you to defer making a decision. Often joint life annuities are taken out and then the spouse pre-decease’s the annuitant. This means that you have taken a lower pension for a benefit you will never need.
Income drawdown can be a complicated area.For further information contact us today – our friendly qualified advisors will help you find the best solution for you.