How does it work?
What income can I take - what are the options?
With new pension freedoms you can chose how much of your pension you want to move into drawdown. You can usually take up to 25% of each amount you move as a tax-free lump sum, and keep the remainder invested, drawing taxable income directly from the pension. You can also choose to convert your entire pension to drawdown all at once, or you can convert smaller segments as and when you need them (known as partial drawdown).
One way to draw income from a pension is to take only the income generated by the underlying investments such as the dividends or income from shares, funds or corporate bonds. This is known as taking the 'natural yield' and generally carries lower risks than drawing on capital (described below), although the value will still rise and fall.
Income payments are made from the cash you have available on your drawdown account (Vantage SIPP) so you will need to ensure you have enough cash to meet your required payments. Selling investments to create cash from which to make withdrawals is known as 'drawing on capital'. Here the value of your pension will fall over time if your withdrawals exceed the amount by which your pension grows. This can become a particular problem if investment performance is poor - you may need to reduce the level of income you take or stop taking income altogether.
One-off lump sums are also possible before you enter drawdown (known as UFPLS, or an Uncrystallised Funds Pension Lump Sum), Compare drawdown with taking lump sums via Uncrystallised Funds Pension Lump Sum »
When making your choice you need to consider:
- Income is not secure and could run out if investments don't perform as expected
- How much you take out - too much and it might run out
- How long the pension might need to last - i.e. how long you will live
- You may want to keep a cash buffer in case of market falls (consider also keeping some of your tax- free cash aside for this)
All investments carry risk. Investments rise and fall in value so your pension could still be worth less in future than it is today, and in the worst case it could be worth nothing at all. This means if you have no other retirement income, you will be left reliant on the State. Also, yields will vary over time and so the income you receive in drawdown is not guaranteed like it is with an annuity.
If you are unsure if drawdown is right for you, we strongly suggest you seek advice.
You can choose to convert your entire pension to drawdown all at once from age 55, or you can convert smaller segments as and when you need them (known as partial drawdown). This can be tax efficient as the tax-free cash can be used to supplement income in the early years.
What about tax?
Drawdown providers are required to deduct tax, where applicable, before the withdrawals are paid out.
Withdrawals will be added to your income in that tax year and subject to any further income tax. Large withdrawals could result in you being pushed into a higher tax bracket.
When you first take a taxable lump sum or income from a pension, it is likely that emergency tax will be deducted, unless your retirement provider has been supplied with a current original P45. If they are not provided with this, emergency tax will be deducted until HMRC send your correct tax code directly to your pension provider. More tax may be deducted than you owe, in which case you will need to reclaim this from HMRC directly. The tax you pay will depend on your circumstances and tax rules can change in the future.
Anything else to consider?
- Ensure you fully understand your options. Drawdown in the Vantage SIPP is offered without advice. Due to the high risk and complexity, if you are at all uncertain about its suitability for your circumstances, we strongly suggest you contact us for advice. You should carefully consider your overall financial circumstances and other retirement goals or plans when making your decision. If you would like to explore a blend of secure and variable income, please have a look at our new Retirement Planner.
- Consider the charges you might pay. Most investments carry charges, and the income you ultimately receive depends on the returns from investments, less any charges. Therefore it is important you consider the charges of your drawdown plan as well as those of any of the other options you are considering. See the charges of the Vantage SIPP
- Withdrawing money from your pension may reduce any means tested benefits you receive. Withdrawals from your pension may count towards capital or income for the assessment of any means tested benefits. You can find more details about means tested benefits at www.gov.uk/benefits-calculators.
- New pension rules make investment scams more likely. Once money is drawn from a pension, you should be careful where you re-invest it. Investment scams exist. These scams tend to be carried out by firms which are not regulated and warning signs include cold calling or texting, the promise of unique or unusual opportunities offering quick, easy profits or something which seems too good to be true.
- Creditors are more likely to be able to call on any money you withdraw from your pension. Any money held in a pension may be protected from your creditors if you are in debt and they take action against you. Once you take it out any protection could be lost.
- Keep a cash buffer. Investors might consider keeping a cash buffer of around a year's worth of income to reduce the risk of having to sell investments when stock markets have fallen in value.