Increased Income from Pensions?
The traditional way of taking income from a pension plan is via annuity purchase. With this route the capital sum in the pension (less any tax-free cash) is exchanged for a lifetime income. Various options can be included such as a dependents pension, payment guarantee period and escalation. The fact remains however that the capital sum is exchanged for an income for life.
For some “Income Drawdown” is a preferred method of taking an income from a pension pot. Instead of exchanging the capital sum for an income, the capital is left invested and capital withdrawals are taken to supplement income. Meanwhile the residual capital remains invested with the the potential to grow and provide an increasing future income. There are also other advantages such as the ability to leave the capital sum to a surviving spouse who can continue the arrangement or purchase their own annuity. The fund can also be left to other family members such as children, subject to 55% tax. The tax rate might sound high, but with an annuity the option to leave capital to family members is non-existent. (It is also less than the combined effect of receiving income after deduction of income tax and then suffering inheritance tax on the unspent income.)
In order to preserve the capital for the lifetime of the contract holder there are strict limits as to how much capital can be withdrawn each year. This must be between £0 and 100% of the limit set by the government’s actuary department (known as the GAD rate). The upper limit increases with age. The amount of capital that can be withdrawn is reviewable every 3 years but where the underlying fund has continued to grow there is the prospect of a higher future income to offset the impact of inflation. For many pensioners inflation is the big enemy because a fixed level of income loses purchasing power over time.
In April 2011 the government changed the upper drawdown limit from 120% of the GAD rate, reducing it to 100% in order to prevent investors from depleting their savings too quickly. This effectively brought the maximum level of income available under drawdown contracts down to the level provided by an equivalent annuity.
This change is now to be reversed. Chancellor George Osborne announced plans to return the upper limit for drawdown to 120% of the GAD rate in his Autumn Statement in December 2012, but gave no date for the change. It has now been revealed that the new drawdown limit of 120% will be introduced from 26 March.
Anybody already in drawdown will have the opportunity to increase their pension income at their next review. For anybody thinking of taking the benefits from a pension policy and about to retire this presents a golden opportunity that needs to be considered carefully before tying into an annuity contract, that once set up can never be changed. Certainly for somebody that wishes to release tax free cash from their pension without taking an income or the full level of income at the present time, this type of contract could be the ideal solution.
Graham Westhall is a Chartered Financial Planner at SWLaw Investment and Financial Planning Ltd and will be delighted to help you with your pensions queries.