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Unsecured Pensions (Income Drawdown)

 

We suggest you read our Introduction to annuities before you read this section

Unsecured pension / Income Drawdown

While conventional annuities are highly secure but inflexible, Income drawdown is at the opposite end of the spectrum and is highly flexible but much riskier.

Third way products which will be covered later, lie between the two extremes.

Since the 'Pension Freedom' changes from April 2015 Income Drawdown has no minimum income requirement associated with it, and drawdown is subject to the individual's marginal rate of tax. Also as a result of the changes all individuals with DC pension pots will be offered free and impartial face-to-face guidance, see www.pensionwise.gov.uk

Drawdown requires the client to accept the on-going investment risk and if the pot is too small, the possibility of losing a significant chunk of your pension is obviously greater than if you have a large pot. 

 

Aims of Unsecured Pension

The main purpose of an Unsecured Pension is to provide income flexibility including delaying the the time at which an annuity is purchased, thus for example avoiding being locked into low annuity rates which may apply at the time of retirement.

  • The option enables investors to retain control over their pension investments and allows them to continue to be invested in the markets.
  • The option enables the policy holder to buy an annuity at a time that is best suited to them and hopefully when annuity rates are more favourable.

It can also postpone the decision of deciding which type of annuity to lock into e.g. providing a contingent pension for a partner and selecting a level of increasing pension.

How It Works - Basics

Your current pension fund is either converted into an Unsecured Pension, if offered by the existing provider, or transferred to one which does. You can opt to take a tax free lump sum up to the maximum of 25% of the accrued fund. (Since April 2015 you can take 100% but subject to your marginal tax rate).

The remainder of your fund is invested in an appropriate portfolio in accordance with your agreed risk profile and income requirements. You withdraw an income from the fund each year and this is generally taxed as earned income, with Income Tax deducted at source.

If you are one of the few whose pension fund exceeds your Lifetime Allowance (£1 million in 2016/17) you will be subject to an additional tax charge when benefits are taken.

Income flexibility

The amount of income you are allowed to take each year must be no greater than the maximum set by the Government Actuary's Department (GAD). The maximum limit 150% (from 27th March 2014) is taken from a table produced by the GAD and is related to a single life annuity that a person of the same age could purchase.

Although there is a maximum limit there is no minimum and it is possible to elect to take an income at any level from nil up to the maximum. The amount of income withdrawn each year can be varied up or down and the institutions that provide these plans will usually offer a choice of income payment periods from annually to monthly.

The maximum limit is reviewed every 3 years up until age 75 and then annually thereafter. On the relevant anniversary, the limits are re-set using the same tables and applying the new maximum rate, as defined by your then age, against the balance of the retirement fund remaining. At this time, you may have to change your income to fall within the limits.

Advantages and Disadvantages of Unsecured Pensions

Advantages

Pension fund withdrawal is especially attractive in the following situations:

• You want to take a substantial tax-free cash sum, but do not need all of the income which an annuity would provide.

• If you and/or spouse are relatively young and in good health, this makes annuity purchase relatively less attractive because of the lower mortality factor. Therefore you can take advantage of a longer timescale in which to take on the rewards and risks associated with equity-based investment.

• You are not entirely dependent on the income from the pension plan and can therefore afford to see fluctuations in its level. Preferably, income withdrawals should be kept as low as possible to avoid the possibility that poor investment performance will erode the value of the fund.

• If you believe that interest rates and therefore annuity rates are temporarily at low levels and might increase again.

You need a flexible income that might be relatively low to start with, but might need to be higher after a few years have elapsed.

Disadvantages of Unsecured Pension

• There are often relatively high charges levied by both the adviser and the pension provider for the considerable amount of administration and advice involved in running an unsecured pension arrangement.

• By investing in safe investments like cash and fixed interest securities, you are bound to receive a lower lifetime income than is available from an annuity, which has the advantage of the mortality factor.

• Investing in assets that might provide the extra returns that could out-perform an annuity involves investment risk. The shorter the time-scale to annuity purchase, the higher is the risk.

Variants and Further details

You can read more detail on income drawdown including the variants of income drawdown called Capped Drawdown and Flexible Drawdown.

 

NEXT STEPS

Learn about the more complex options that you haven't read about yet:
Unsecured Pensions (also known as Income Drawdown), or
Phased Retirement or
Third Way options

or return to the start of the annuities guide.

Once you have understood as much as you need to about annuities, be sure to use our Retirement Finance Checklist in your run up to retirement.

However if you feel that you need some help from a financial advisor, then visit our section on obtaining financial advice, or our page on Laterlife selected services and associated advice.

 

 
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