Although the majority of people believe that at retirement, pension income from a personal pension has to be paid via an annuity; there are in fact 2 alternatives: Capped Drawdown and Flexible Drawdown.
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What is Drawdown?
The concept of Income Drawdown was first introduced by the Finance Act 2005.
The idea is that rather than use your entire pension fund to purchase an annuity, you can instead take an income directly from your existing fund. You are in control of how much income you take, having the ability to turn the ‘income tap’ on and off, provided you do not take more than the maximum allowable income each year.
Drawdown was initially available via an Unsecured Pension (USP) prior to age 75 and an Alternatively Secured Pension (ASP) post age 75.
In 2011 the coalition Government formed the new drawdown methods of capped and flexible to replace USP and ASP because of the income restrictions and higher tax charges for people taking ASP. The reality was that whilst many people used USP, at age 75, switching to an annuity became the most common option.
How do Capped and Flexible differ from the existing methods?
Capped is very similar to traditional drawdown, i.e. your pension fund remains invested, you can drawn an income directly from the pot of between nil and 100% of the maximum annuity rate determined by the Government Actuary’s Department, or GAD and you pay income tax on the amount you draw.
Flexible is very different because it has no maximum income limit. This means that you can draw your entire pension fund as one taxable lump sum.
The key point however is that flexible drawdown is only available if you can meet the stipulated minimum income requirement (MIR) of at least £20,000 of secured income, that will neither drop below this level or is capable of being surrendered.
This can be via:
- A lifetime annuity
- A scheme pension (with a minimum of 20 members)
- State pension
- Payments from a registered overseas pension scheme
- Payments from the Financial Assistance Scheme
Income from an existing drawdown plan does not count because the income is not secured.
In the year that you set up flexible drawdown, you are not able to make any pension contributions.
It is possible to move your pension from capped to flexible but not the other way around.
Which option is best for me?
Although the answer to this question is very in-depth and the comparisons between the pensions are beyond the scope of this blog, in simplistic terms:
An Annuity is the best option if you would rather have the security of a fixed income for life which will not decrease and is not reliant on investment returns.
Capped Drawdown is the best option if you wish to have control over the level of income you draw from your pension but you understand that the value of your overall pension fund is dependent on investment returns and the income is therefore not guaranteed and may decrease.
Flexible Drawdown is the best option for you if you have enough income to fund your retirement and you would rather have control of your pension funds outside of the imposed income restrictions.