Income drawdown, also known as an unsecured pension, is a riskier though potentially more rewarding alternative to lifetime annuities. Essentially, you are allowed to take money from your pension directly yet the money that remains continues to be invested.
Staying In Charge
Control is the most important element in income drawdown and is its most attractive feature. All responsibility for the security of your pension rests on your shoulders as you can choose the investments. If you make the right investment decisions and have enough self-control to resist the urge to withdraw large amounts, it is likely you will make a profit. Equally however, poor decisions are often heavily punished.
Should you die while your pension is still in income drawdown, the remaining value of the fund can be left to the person(s) of your choosing though they will be hit with a 35% tax charge if it’s a lump sum. Alternatively, you could leave them the value of the pension which could provide a taxable income.
With a contracted out pension, your civil partner or spouse must have a certain level of income provided for them. It does not matter if it comes in the form of annuities or income drawdown. In the event you have neither a spouse or civil partner, the fund can then be passed onto a beneficiary of your choosing.
You are allowed to buy a lifetime annuity with an income drawdown fund at any time. Once you reach the age of 75, income drawdown must be converted into an annuity or else it can be placed in an Alternatively Secured Pension (ASP). The ASP is basically an extension of income drawdown though you enjoy less benefits and the amount that can be withdrawn is also less. Those who have not set up an annuity by the time they reach 75 will automatically find that their pension fund is moved into an ASP.
Income drawdown undoubtedly has many benefits but it should not be seen as some sort of Holy Grail by those looking for flexibility in their pension. The catch is that the value of the fund could well decrease rapidly. In fact, if you are careless when withdrawing money and make some poor investment choices, you could find your fund almost wiped out. This would be a complete disaster because you would then be reliant on the state pension and any retirement plans you had would be destroyed. Therefore, only consider income drawdown if you understand and are prepared for these risks.
Explaining Income Drawdown
The first step is to decide just how much of your Self Invested Pension Plan (SIPP) fund or pension you would like to invest. It is then possible to withdraw up to a quarter of this money in tax-free cash before using the rest as a form of taxable income. As there is no minimum amount for withdrawals, you could theoretically withdraw no money at all. The income that is withdrawn will be subject to PAYE (Pay As You Earn) at source. It is then up to you to decide where your pension money should be invested. As the market is volatile, be sure to regularly check how your investments are performing.