Everything you wanted to know about drawdown pensions
An income drawdown or drawdown pensions is when you take money from your pension fund while leaving the sum invested in the stock market. It is the alternative to anannuity, where you hand over your pension savings to an insurance company in exchange for a guaranteed annual income for the rest of your life. The investment of these funds is made in combinations such as share, bonds and even gifts at times. The amount that is withdrawn is usually evaluated every 5 years, but income drawdown investors sometimes seek to make more frequent reviews of their circumstances. The facility is typically open to individuals over the age of 55. Here are a few things you need to know about drawdown pension in order to help you make an informed decision.
Minimise tax deduction:
Drawdown pensions allow you to take 25% of the amount of pension as alump sum and that too tax-free. The remainder of the sum can be redeemed in varying rates of tax payment. This holds true also in thecase of you are not willing to withdraw directly. The tax rules are very flexible and user-friendly in the drawdown pensions scheme, giving you plenty of room to assess your financial needs and requirements.
The rest of your money remains invested:
This is one of the key selling points of drawdown pension. It lets you reap the benefits of security while your money continues to profit from the stock market. The problem, most people on the brink of retirement face, is that they are unsure of what to invest in, whether to prioritise security or maximise yield. The drawdown pension appears to strike the ideal balance as your pension flows in unhindered while your savings keep accruing interest.
Remaining money passed on to beneficiary:
In the case of drawdown pensions, if the entire sum is not utilised in your lifetime, then the remaining money is passed on to a beneficiary or nominee. Therefore, drawdown pensions also provide security to your family after you are gone. If you die before the age of 75, then the drawdown pension is passed on to the nominee free of any tax deductions. But if you die at or over the age of 75, then the sum is not tax exempted. Taxes will be deducted at the beneficiary’s marginal rate. They can then continue to redeem the drawdown pension and carry on, but they will have to pay the tax on their income. They can also use the remaining money to purchase an annuity.
The drawdown pension scheme grants you the liberty to design your retirement the way you see fit. The rules are flexible and convenient. While drawing the pension, you get to decide which assets you wish to withdraw them from and which assets remain afloat in the stock market. You can also change the order of these assets, by following a few steps which are protocol. If your investments include a combination of cash, bonds and equities, then ideally you should draw money from the cash section first, give the riskier assets a chance to recover from their position. When the time comes to sell your assets, sell the low-risk ones first, such as government gifts. This way you can make sure your money is safe but also prevent stagnation of the investment.
Ownership of capital:
Being retired does not have to mean letting go of capital. Drawdown pensionenables you to have a stable pension while simultaneously being an entrepreneur of sorts. Most retirement schemes require you to invest in a rather dull or stagnated manner. Your capital is in the doldrums and you do not see your money working as much as you would like it to. But with drawdown pensions, your money continues to remain yours and you continue to have ownership of your capital. This is what makes it such a lucrative option.
But like all market schemes, the drawdown pension is not foolproof either. It definitely is low risk, and easy to manage, but not without its share of downsides. Here are a few cons you must keep in mind and consider before you invest.
No guarantee of future returns:
While drawdown pensions assure heightened rates of immediate return, the future may be a little more uncertain since it is the stock market under concern here, the market may tend to be a little unpredictable. Annuity pension schemes, though may reap lower yields, do offer undisputedly greater security in terms of future returns.
High withdrawal risks:
High withdrawals are not a sustainable way to avail the feature of drawdown pensions they may suit your immediate needs, but could be problematic in the long run when your pool of assets begins to run dry. There is a very high chance of exhausting your resources. Moreover, the higher the income you withdraw, the lesser you are leaving behind for your dependents. Constant withdrawal of income may deprecate the value of the asset in the market, thereby making it redundant and an eventual liability.
Since the rules are more flexible, it requires greater human intervention which in turn means greater administrative costs. Moreover, the level of income may also change after the duration of 5 years or fewer. The availability of so many concessions and waivers makes it highly labour intensive, creating potential for high maintenance costs.
Stock market uncertainty:
A great part of your future depends on the stock market performs and how your shares fair in the market. This has thepotential for profit, but caution must also be exercised since the markets can be volatile. There is a chance that you may lose more than you invest in the first place. This might not jeopardise your position, but the fate of your beneficiaries who will have to bear the burden of the losses.
Drawdown pensions promise higher returns, but they also do run a risk of fizzling out owing to the risk involved. Talk to your advisors before you make any decision and keep yourself informed about any and all developments.