Also known as income drawdown, this is among the most flexible investment fund options available and can be purchased until you turn 75. It is especially useful for those who have other sources of income or who have large funds. With income drawdown, you will be allowed to withdraw a certain amount of taxable income from your fund each year. The remaining money will continue to be invested into funds. The potential for growth from income drawdown is considerable and its flexibility is appealing. You have the final say on how much can be withdrawn from the fund and maintain complete control over your money.
If you die before you reach 75 and have not converted your money into an annuity, it is possible to leave the remaining balance to beneficiaries of your choosing. They will be allowed to withdraw the entire amount at once but will be forced to pay 35% of the cash in tax. A later article explains how death benefits can actually be more lucrative than anything offered by a lifetime annuity.
As one might expect, there are certain limits on the amount of money that can be withdrawn from the account per annum. These limits are reviewed every five years. As there is no minimum income, you could take out 25% of your fund tax-free and use the rest to invest in funds. Depending on the fund, you may be able to withdraw more money than you could from a regular single-life annuity.
The whole point of the fund is of course to watch it grow in value. One strategy is to have a couple of year’s worth of income available in cash with the rest invested in different funds which include stocks, shares and bonds. If you have a Self Invested Personal Pension (SIPP) and income drawdown, you are providing yourself with the best possible combination of flexibility and possibility of growth.
One problem with income drawdown is the fact that the charges involved in setting it up are likely to greatly exceed those associated with regular lifetime annuities. You cannot simply activate income drawdown and ignore it because it is subject to constant review. It is also much riskier than normal annuities because its value could rapidly fall as well as rise. A fund that performs well will give you an excellent income which will do more than allow you to live comfortably. However, if the fund underperforms severely, you may find that future financial plans which depended on a reasonable return on investment are put on hold.
You can use your income drawdown fund to purchase an annuity whenever you choose. Once you reach 75, you must use your fund to buy some form of annuity or else this money has to be converted into an Alternatively Secured Pension.
Providers such as Hartford Platinum and Lincoln have offered options to pension holders which are almost a cross between annuities and income drawdown. Variable annuities are far more common in America though they are finally getting something of an audience in the United Kingdom. Essentially, you will still be able to invest but can also benefit from guaranteed capital. Those who are not interested in annuities or income drawdown may find these to be an attractive alternative. However, research has shown that such plans are extremely expensive and are not worth any serious long term investment. It is more prudent and cost effective to divide your money up into annuities and income drawdown for the best of both worlds.
If you are trying to determine whether income drawdown or annuities are the best option, you may come across a phrase called ’Morality Drag’. Annuities work because the people who die before their life expectancy pay for those who live longer. In every single group of annuities, there will always be people who live longer than expected and those who die before their time. If you purchase income drawdown instead of an annuity initially and only decide to purchase the annuity later on, any cross subsidy you would have benefited from because of the early mortality of those who purchased annuities will be gone. In effect, your fund has to perform better in order to catch up on those who bought theirs early. This scenario is known as ‘Mortality Drag’.