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What's All the Fuss about Flexible Drawdown

Richard Beardsworth Pension Expert

By Richard Beardsworth.

Independent Financial Advisor

More Reading on Pension Drawdown...

With the pension freedoms of 2015 came quite a few more options for accessing pension monies in retirement. In light of that, a hot topic among financial advisers and pensioners alike is the concept of the flexible drawdown. What used to be a tightly regulated means of using pension savings has been loosened up considerably with the introduction of the flexi-access drawdown scheme.

In this guide, we will discuss flexi-access and why it is generating so much excitement among pension savers. Suffice to say that this new option can be more favourable than purchasing a lifetime annuity or being subject to a capped drawdown under previous rules.

How Income Drawdown Works

The basic concept of income drawdown is relatively simple. You save in your pension pot over the lifetime of your career in order to have money with which you can pay your bills once you stop working. Drawing down is simply the process of gradually accessing the money you have saved and using it as income. Essentially you have put away a portion of what you earned in order to support yourself after working ceases.

Some people will choose to purchase an annuity with their pension pots at retirement. This option is certainly legitimate for individuals who want a guaranteed lifetime income with no further worries. The disadvantage of annuities is their poor rates of return. Annuities are not financially attractive because they are tied to gilt bonds and interest rates. As long as the Bank of England base rate remains low, gilts will not do very well.

Income drawdown bypasses annuities by transferring the saver's money into a new account with various investment options. The saver can choose how to disburse monies within those funds in order to generate the best possible returns commensurate with risk aversion. It works like this:

You decide to convert your pension pot to a flexi-access pension at retirement. Upon conversion, your pension operator offers you a set of different funds into which you can place your money. By looking at the performance of those funds and considering any advice you may receive from your financial adviser, you direct how your pension monies will be invested. Even as you draw income from your pension, any money that remains invested continues to generate returns.

Flexi-Access Drawdown Basics

Prior to 2015 pension freedoms, savers could engage in drawdown contracts under one of two options. The first was a capped drawdown that was governed by limits set by the government. Pension savers could only draw up to that annual limit. The second option was the flexible drawdown. Under a flexible drawdown pension, savers could withdraw as much as they wanted as long as they met minimum income requirements.

Neither contract has been available to pensioners since April 2015. They have both been replaced by the new flexi-access drawdown scheme. This scheme is essentially the old flexible drawdown scheme with a lot more freedom added in. We already talked about the ability to invest in various funds in order to generate returns, but there are other things about flexi-access you should know.

For example, you can draw income from a flexi-access scheme in any way you see fit. You can take income every week, every month, or via a single annual payment. Alternatively, you could take income without establishing a regular payment schedule. Just take lump sum withdrawals as you need them.

Do you want to continue making contributions to your pension even after you start drawing down? You can. Just keep in mind that any future contributions may be affected, for tax purposes, should your initial withdrawals exceed the 25% tax-free limit.

Do you want to gradually convert your current pension pot into a flexi-access scheme in stages? You can do that as well. The only requirement here is that your pension operator offers such a product. Not all do. Furthermore, not all pension operators offer even a basic flexi-access scheme. You may have to shop around to find one suitable to your goals.

Advantages and Disadvantages of Flexi-Access Drawdown

Certified financial advisers always recommend that pension savers learn as much as they can about each of their options before deciding how to use their money. This recommendation certainly applies to flexi-access drawdowns. There are quite a few advantages to flexi-access, but there are disadvantages as well.

What are the advantages of choosing flexi-access drawdown? These are as follows:

  • Income can be withdrawn on a regular schedule or as needed
  • Withdrawal amounts can be whatever the saver wants them to be
  • Savers can withdraw up to 25% tax-free
  • All capital remaining in the pension scheme continues to earn
  • Withdrawn money can be put into more profitable investments
  • Any money remaining at the time of death can be passed on to beneficiaries.

The ability to invest your pension savings elsewhere is one of the main driving forces that encourages people to choose flexi-access drawdown. In other words, a saver may not necessarily be impressed with the performance of his or her current pension scheme but is unwilling to risk everything. The saver chooses flexi-access drawdown so that he/she can use his/her 25% cash lump sum to invest in more aggressive opportunities while still drawing regular income from the remaining 75%.

Flexibility is the key here. Still, that flexibility comes with some disadvantages. Pension savers should understand the following before choosing flexi-access drawdown:

  • Every withdrawal reduces earning power by reducing capital
  • The returns on remaining capital are never guaranteed
  • All withdrawals in excess of the first 25% are subject to income taxes
  • Withdrawals could push a saver into a higher tax band
  • Any funds withdrawn and invested elsewhere can be lost
  • Not properly planning for the future could mean running out of money prior to death
  • Income drawdown could leave very little to pass on to beneficiaries
  • Unlike annuities, income drawdown does not guarantee income for life.

As you can see, there is a lot to consider about flexible income drawdown before making a decision. The best way to approach the decision is to first consider what your retirement income goals are. The amount of money you need to enjoy your preferred lifestyle will largely determine not only how you invest, but also how you access your monies once you stop working.

Once you understand your retirement goals, you can begin to get a good idea of how much money you will need to reach those goals. This will provide a basic outline directing you how to invest, how to save, and what to do once it is time to make a choice about flexible drawdown. The good news is that you have a lot of flexibility. You can make decisions now based on future projections, and still make changes to your plans if need be – which leads us to the last point of this discussion.

Start Planning for Retirement Now

Hopefully, you are not reading this as a 50-year-old who has never saved for retirement before. If so, we want to encourage you that you're never too old to save. Putting away money for the remainder of your working career is better than not putting away anything at all, even if you can only manage a small amount.

As for younger workers, this last section is for you. It is all about beginning retirement planning now while you are still young. It has been said that the pension investor's most important asset is time. Why is that so? Because it is time that allows you to take a small amount of money and grow it into a substantial retirement. The more time you have, the greater your earning potential.

Whether you are fresh out of university or you have already been working for a number of years, now is the time to start planning for your retirement. You and your financial adviser may come up with a plan based on the eventual goal of taking advantage of flexible drawdown to provide for your retirement. In such a case, you would devise your pension savings and investments accordingly.

Alternatively, the plan you come up with may ultimately result in purchasing a lifetime annuity at retirement. This kind of plan would dictate a different strategy for saving and investing. The point is to start planning now so that you have the money in place regardless of your goals for accessing pension monies.

Flexible drawdown is just one option for retirement. You need to compare that option with all of the others on the table. Again, this is why the advice of a certified financial adviser is so important. To that end, we urge you to contact us today to learn more about your options. We can explain flexible drawdown, annuities, and all of the other choices now available to pension savers.


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