Income Drawdown

Income Drawdown is a personal pension plan which accepts existing pension plan funds. It enables you to put off buying an annuity (an income for life) until several years into retirement. Instead you withdraw a regular income from your pension fund, within limits set by the HM Revenue & Customs. You can vary the amount over time as your needs change. The rest of your fund remains invested. Future income is not guaranteed. It depends on the level of income drawdown, investment performance and future annuity rates. Please note that the value of the remaining fund can go down as well as up and is not guaranteed, and that annuity rates can vary over time. So you could end up with a lower pension than if you'd chosen a conventional annuity straight away.
It would mostly be suitable for dentists who have accumulated a significant amount of money in a personal pension. For those with NHS pension schemes in most circumstances they would tend to be better off drawing their pension direct from the NHSPS.

How does it work?

When you start taking your pension benefits you need to decide (after taking financial advice) whether income drawdown is right for you. If it is, you put your retirement fund into an Income drawdown Plan. You then take your tax-free cash sum from the Plan and leave the rest of your fund invested to provide your pension through income withdrawals or one-off withdrawals. The maximum (and minimum) level of income you can take over the first 5 years is based on the invested fund and HM Revenue & Customs rules. These are based on the calculations of the Government Actuary's Department (GAD). The maximum withdrawal is 120% of the GAD annuity and there is no minimum withdrawal amount. You and your adviser agree how much income you take each year within these limits.
Every 5 years thereafter we work out revised income limits based on your remaining invested fund and the HMRC's annuity rates at that time, until you reach age 75. You should regularly consult your financial adviser to check that the level of income you are taking is suitable for your circumstances.
If by the time you reach age 75 you do not wish to buy an annuity we will write to you with details of the options available.
Protected Rights Benefits are your entitlement from the State Second Pension, previously the State Earnings Related Pension Scheme (SERPS). This plan allows you to use this part of the fund for income drawdown. Up to 25% of the Protected Rights fund can be taken as a tax-free cash sum

Who could it be suitable for?

Income Drawdown can be taken out by people aged between 50 and 70 (from 2010 the lower age will be 55). It could be suitable for you if:

  • You want to vary your income over time to reflect changes in your circumstances.
  • You want your pension fund to continue to benefit from potential growth and are prepared to accept the risk that its value may fall rather than rise.
  • You have other sources of income so you may not need such a high income from your Income Drawdown Plan in the early years of retirement.
  • You want to attempt to maximise the benefits your family receive on your death and give them maximum choice about how they receive these benefits.
What are the drawbacks?

The main drawback of Income Drawdown compared to the conventional annuity route is the greater degree of risk. For example:

  1. Your income is not guaranteed - it depends on the level of income drawdown, investment returns and future annuity rates. Your fund may not perform as well as you had expected and the benefits you get may end up lower than if you'd chosen the traditional route.
  2. The withdrawals you make to provide an income reduce your remaining fund and may erode the capital value of the remaining retirement fund below that originally invested, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income when the annuity is eventually purchased or an amount less than you would have received under an existing arrangement. It is possible for the capital value of the plan to fall below the amount of the initial investment.
  3. Annuity rates vary over time. They may not improve and may worsen. If you leave it until the last moment to convert your fund into an annuity, you will have to accept the rates available at the time.
  4. The charges you pay for Income Drawdown will be higher than for a conventional annuity.
  5. If a high level of withdrawal is made every year this could mean you, or your spouse, civil partner or dependents if you die, get a lower level of income in the long term.
  6. Pension provision for your spouse, civil partner or dependents may not prove adequate compared to your previous arrangement.
  7. If, at age 75, you choose to take income withdrawals known as Alternatively Secured Pension, income may be reduced because of the more restrictive rules that apply to such a pension.
  8. Annuities rates are set knowing that some people will die before their average life expectancy and some will live beyond it. Annuities are set up on the basis that the unused funds of those who die earlier than expected are available to help to pay the annuities of those who live on. This process is likely to be available and this will be reflected in the annuity rates. To compensate for this, the investment needs to grow by an additional amount. This process is called mortality cross-subsidy. By delaying buying an annuity, you lose the mortality cross-subsidy generated by those who die before you buy an annuity.