Keeping your pension funds invested beyond your normal retirement date

Income Drawdown or Unsecured Pension (USP) became available in 1995. It allows people to take an income from their pension savings while still remaining invested and is an alternative to purchasing an annuity. You decide how much of your pension fund you want to move into drawdown and then you can normally take a 25 per cent tax-free lump sum and draw an income from the rest.

Pensioners funding their retirement through Income Drawdown are permitted to keep their pension funds invested beyond their normal retirement date. They continue to manage and control their pension fund and make the investment decisions. There is also the opportunity to increase or decrease the income taken as they get older. However, the fund may be depleted by excessive income withdrawals or poor investment performance.

From 6 April 2010 you are now able to choose to take an income from your pension fund from age 55 (previously this was from age 50). Tax rules allow you to withdraw between 0 per cent to 120 per cent (2010/11) of the equivalent relevant annuity you could have bought at outset. These limits are calculated by the Government Actuaries Department (GAD) and the rates are reviewed every five years. There’s no set minimum, which means that you could actually delay taking an income and simply take your tax-free cash lump sum. The amount of yearly income you take must be reviewed at least every five years.

Under current rules, from age 75, Income Drawdown is subject to different government limits and becomes known as Alternatively Secured Pension (ASP). If you’re already receiving income from an Income Drawdown plan and have not yet purchased an annuity, currently when you reach the age of 75 it will become an ASP.

You will still be able to receive a regular income while the rest of your fund remains invested, but the minimum amount you can withdraw is 55 per cent (2010/11) of an amount calculated by applying the funds available to the GAD table, while the maximum is 90 per cent (2010/11). These limits must be reviewed and recalculated at the start of each pension year.

It is important to be aware that the government is currently consulting on changes to the rules on having to take a pension income by age 75 and, following a review conducted in June 2010, plans to abolish ASP. Instead, Income Drawdown would continue for the whole of your retirement, although the proposed withdrawal limits are significantly less than for ASP and the vast majority of people may be better off purchasing an annuity.

As an interim measure (and until ratified in the Finance Act), the government is to increase the age by which an annuity must be purchased to 77, for those aged under 75 as at 22 June 2010.

The new rules are likely to take effect from April 2011 and, under the proposals, there will no longer be a requirement to take pension benefits by a specific age. Tax-free cash will still normally be available, but only when the pension fund is made available to provide an income, either by entering Income Drawdown or by setting up an annuity. Pension benefits are likely to be tested against the Lifetime Allowance at age 75.

Currently, on death in drawdown before age 75, there is a 35 per cent tax charge if benefits are paid out as a lump sum. On death in ASP, a lump sum payment is potentially subject to combined tax charges of up to 82 per cent. It is proposed that these tax charges will be replaced with a single tax charge of around 55 per cent for those in drawdown, or those over 75 who have not taken their benefits.

If you die under the age of 75 before taking benefits, your pension can normally be paid to your beneficiaries as a lump sum, free of tax. This applies currently and under the new proposals.

For pensioners using drawdown as their main source of retirement income, the proposed rules would remain similar to those in existence now with a restricted maximum income. However, for pensioners who can prove they have a certain (currently unknown) level of secure pension income from other sources, there will potentially be a more flexible form of drawdown available that allows the investor to take unlimited withdrawals from the fund subject to income tax.

As a general rule, you should try to keep your withdrawals within the natural yields on your investments. In this way you will not be eating into your capital.

Since 6 April 1996 it’s been possible for Protected Rights money – funds accrued from contracting out of SERPS or State Second Pension (S2P) – to be included in an Income Drawdown plan, but before A-Day Protected Rights couldn’t be included in a phased Income Drawdown plan.

For investors who reached age 75 after 22 June 2010 but before the full changes are implemented, interim measures are in place that, broadly speaking, apply drawdown rules and not ASP rules after age 75. These interim measures are expected to cease when the full changes are implemented. Any tax-free cash must still normally be taken before age 75, although there will be no requirement to draw an income. In the event of death, any remaining pension pot can be passed to a nominated beneficiary as a lump sum subject to a 35 per cent tax charge.

As with any investment you need to be mindful of the fact that, when utilising Income Drawdown, your fund could be significantly, if not completely, eroded in adverse market conditions, or if you make poor investment decisions. In the worst case scenario, this could leave you with no income during your retirement.

You also need to consider the implications of withdrawals, charges and inflation on your overall fund. Investors considering Income Drawdown should generally be prepared to adopt a significantly more adventurous attitude to investment risk than someone buying a lifetime annuity.

In addition, there is longevity to consider. No-one likes to give serious thought to the prospect of dying, but pensioners with a significant chance of passing away during the early years of their retirement may well fare better with an Income Drawdown plan, because it allows the pension assets to be passed on to dependants.

A spouse has a number of options when it comes to the remaining invested fund. The spouse can continue within Income Drawdown until they are 75 or until the time that their deceased spouse would have reached 75, whichever is the sooner. Any income received from this arrangement would be subject to income tax. By taking the fund as a lump sum, the spouse must pay a 35 per cent tax charge. In general, the residual fund is paid free of Inheritance Tax, although HM Revenue & Customs may apply this tax.