Drawdown: Then and Now
This year Drawdown, one of the main retirement income alternatives to the fabled annuity, turns 20 years old. It’s also the year where Income Drawdown comes of age, as we see major changes to the pensions market thanks to reforms back in April, resulting in access restrictions being lifted.
Comparing drawdown now to how the process looked back in 1995 shows some startling differences.
1995 – When drawdown was first introduced the set-up fees could be extremely high. The set-up fee was often 3% or more of the funds you were hoping to remain invested. There was also usually an annual fee and transaction charges.
2005 – Fees vary between pension providers though there may be a set-up fee and an annual fee – though not likely to be as expensive as back in 1995. Withdrawals have been reported as high as up to £240 per transaction, though Conservative Prime Minister David Cameron is looking to crackdown on this.
1995 – Only a minority of wealthy pensioners were able to take advantage of drawdown for many years following its introduction.
2005 – Following the introduction of the pension freedoms back in April 2015, all pensioners can take advantage of income drawdown – though it isn’t recommended for those with a pension fund of less than £30,000.
1995 – When it was first introduced you had to take a minimum amount from the income drawdown investment each year. This was usually a minimum of 35% of a relative annuity rate. You were also restricted to a maximum 100% of the same calculated annuity rate.
2005 – Following the reforms, there is now no minimum yearly withdrawal or a maximum withdrawal allowance: you can take the whole value at any time if you wish.
1995 – At 75 years of age you were required to use the remaining funds to purchase an annuity.
2005 – Certain pension providers still stick to the rule that you must use your remaining funds for an annuity once you reach 75 years of age.
Tax Charges on Death
1995 – A flat tax rate of 35% was charged if the remaining value was paid as a lump sum. This rate rose to 55% in 2011.
2005 – Should you die before the age of 75, withdrawals will be paid to your beneficiaries with no tax charge. Should you die after the age of 75, tax on the withdrawals is subject to income tax. It does not have to be paid as a lump sum if it may push the beneficiary into a higher income tax bracket.
Income Drawdown is of course not without its risks. For those who are not financially savvy, it could result in you underestimating the length of your retirement and over-spending early on. It also isn’t a secured income, so unlike an annuity it does not guarantee you an income for life. While it is not a necessity, it’s recommended that you seek independent financial advice before making a decision on your retirement income. Some pension providers will insist on this before allowing you to set up an income drawdown scheme.
Despite this, its flexibility, along with the new rules and the opportunity to take 25% of tax-free cash at the start of your retirement means that income drawdown will be taken up by many retirees who felt annuities gave them a poor deal for their lifetime of pension savings.