Since the introduction of Pension Freedoms, more retirees are choosing to leave their retirement savings invested. But before you decide how to take your pension, understanding the ins and outs of using Flexi-Access Drawdown is important.
First up, what exactly is Flexi-Access Drawdown? When you come to take your pension, you can choose to leave your savings invested with the goal of providing a retirement income. It’s a flexible solution; allowing you to take an income when it suits you. As a result, you can increase and decrease withdrawals to suit your lifestyle.
The adaptability offered is attractive for many retirees. According to the Financial Conduct Authority (FCA) figures, between October 2017 and March 2018, over 90,500 pensions entered Drawdown for the first time, a year-on-year increase of 8%. This compares to just below 34,000 retirees purchasing an Annuity during the same period.
As money can remain invested when using Flexi-Access Drawdown, it may be exposed to volatility within the markets. It will mean needing to take a more active approach to monitoring pension investment performance and withdrawal rates. For example, should the value of investments fall, it may be necessary to take a lower income for a period of time to counteract it.
In fact, a survey by Aegon UK found that 43% of retirees were concerned about the impact of current market conditions on their retirement income sustainability. However:
- 58% have not reduced their exposure to equities in the last 12 months
- And 67% don’t plan to take any action, leaving their money where it is
- Just 11% are reassessing their current investment strategies in order to diversify
While Flexi-Access Drawdown could provide you with a flexible income throughout retirement, weighing up the pros and cons is important.
The pros
1. You’re in control of the income your take
The biggest draw for many using Flexi-Access Drawdown is that you can take a level of income that suits you. At times when you have plans that require additional funds, you’re free to take more from your pension. Alternatively, should you not need any further money, you can stop withdrawals, meaning the capital will remain invested. For modern retirement lifestyles, when income needs often change, this can be appealing.
2. There is potential for the value to increase
With your money still invested, there’s an opportunity that the value of your pension will continue to grow. It can provide you with more capital throughout the years and allow your savings to keep pace with, or hopefully exceed, inflation. Remember, historically, investments have outperformed cash assets over the long term. But the past shouldn’t be used as a reliable indicator for the future, as investment risk is still present.
3. You can choose the level of risk
Linking to the above point, you will be able to choose the level of investment risk you’re comfortable with, putting you in control of your finances. Usually, providers will offer several different risk profiles, so you can pick out the one that matches your attitude most closely. Generally, the more risk you take the higher the potential investment returns. But, of course, this comes with an increased risk of investments decreasing in value, as they may be exposed to greater volatility.
4. It can provide a tax-efficient way to pass on wealth
Keeping your money within your pension fund can be an effective way to pass wealth on to your loved ones when you die. If your estate is liable for Inheritance Tax (IHT), pensions can be an effective tool, as they are usually exempt. Money held in a pension is often outside of your estate for IHT purposes. If you die before you’re 75, beneficiaries won’t have to pay any tax at all. If you die after 75, they may have to pay Income Tax.
The cons
1. Measuring your life expectancy can be difficult
Calculating the income you can take should start with your life expectancy. However, it’s a figure many underestimate. For people between 40 and 54, the government projects the average life expectancy will be 87.5 for men and 90.1 for women. Of course, there’s always a chance you’ll outlive the average too. There’s a real risk of taking too much income too soon if you miscalculate your life expectancy. If you live longer than you thought, how would you cope financially?
2. You’ll be responsible for taking a sustainable level of income
As you’ll be in control of how much you withdraw from your pension, you need to take steps to ensure it’s a sustainable amount over your lifetime. The FCA found the average drawdown rate in 2017/18 was 5.8%. This is above the often recommended sustainable level of 4% annually. Your personal circumstances and other sources of retirement income will affect what you can afford to withdraw.
3. Investments can decrease in value
When you choose to leave your money invested, you hope that it will increase in value, but this isn’t always the case, especially in the short term. Investments can decrease in value too and this may affect the level of income you can afford to withdraw. If you’re considering leaving your pension invested, you should assess what you risk profile is before you proceed. We can help you make this decision.
4. Your tax liability can change
As you may be taking out different levels of income when using Flexi-Access Drawdown, your tax liability can change. Making higher withdrawals may push you into the next Income Tax bracket. As a result, understanding what you’re withdrawing and how this can affect tax liability is important.
With the pros and cons of Flexi-Access Drawdown in mind, it’s important to look at your other options too, including purchasing a guaranteed income through an Annuity and taking a lump sum from your pension. To discuss your pension options as you approach retirement, please contact us.
Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
