12th July 2013

Aegon: Flexible drawdown: a 'gold standard' in retirement planning?

When flexible drawdown was first introduced on 6 April 2011, many advisers saw it simply as a new opportunity for clients to ‘cash in’ their pension pots. A client who’s aged over 55 and can meet the minimum income requirement (MIR) can potentially choose flexible drawdown if their scheme allows.

While some advisers thought we’d see clients plundering their pension funds in pursuit of that exotic holiday or soft top sports car, in practice few advisers can justify giving advice on a full encashment due to the additional income tax liability that it brings. Clients won’t want to pay income tax at 40% and 45% on their hard earned pension fund if they don’t have to.

However flexible drawdown has much more to offer and you could even argue that it might become a product of choice, a sort of ‘gold standard’ for retirement planning.
Individuals who have an existing secured pension of at least £20,000 (meeting the MIR) might be able to move into flexible drawdown within their existing scheme, or transfer to another scheme. Once in flexible drawdown, funds can be taken without restriction, with cash payments being part tax free, part taxed at marginal rate.
Any cash taken from the pension fund will immediately form part of the client’s estate for inheritance tax purposes. So it’s worth thinking about how cash is going to be used before removing it from the pension fund.

Flexible drawdown could be a really useful income planning tool where the client wants to supplement his income — especially if that extra income can be provided in the form of tax-free cash or as income which is only going to suffer income tax at 20%.

Here’s an example:

James is aged 60 and has an unvested pension fund of £600,000, as well as a secure pension which is already in payment of £20,000 a year. The existing pension covers his main costs, but he’d like to top up his income to allow him to travel abroad.

If James goes into capped drawdown (and assuming a gilt yield of 2.50% applies when he takes benefits), this could provide a tax-free lump sum of £150,000, plus a taxable (gross) income of up to £26,460 a year (assuming 120% of GAD applies). Don’t forget that under capped drawdown, any residual lump sum death benefits would be subject to a 55% tax charge.

Alternatively he could move into flexible drawdown. In the 2013/14 tax year, James will have a personal allowance of £9,440 and (assuming his full personal allowance is available) could receive an overall income of £41,450 before he starts to pay income tax at 40%. For the 2013/14 tax year, James could take £28,600 from his flexible drawdown plan, providing him with tax-free cash of £7,150, plus additional income of £21,450. This additional income will be aggregated for tax purposes, but will still only be taxed at 20%. This would provide some major benefits for James.

Any remaining pension funds can still be invested in the markets and could eventually be settled as full lump sum on death (as long as they’re paid under a discretionary disposal provision). If any monies are kept unvested, then a full return of fund applies (subject to available lifetime allowance).

Once James has met the MIR he can rest assured that there will be no further need to retest his benefits against it at a later date. Once funds have gone into flexible drawdown they won’t be subject to any of the income restrictions that would apply under capped drawdown (so there’s no need to worry about future changes in GAD rates or percentages).

He can receive his income in a very tax-efficient way. The additional income of £21,450 would only be taxed at 20%, and he could also take £7,150 tax-free cash to spend on his travels.

As far as the provider and adviser are concerned, this top up approach would leave funds under management for many years to come. James won’t have to suffer the heavy tax charges of a full encashment if he simply tops up his income each year towards the higher rate tax threshold.

This planning opportunity is currently popular with scheme members who have benefited from final salary schemes. Think wealthy ‘baby boomers’, especially doctors, police officers, civil servants and company directors. The target market includes those who have final salary scheme pensions in payment alongside other pension funds. It’s also popular with people who can meet the MIR once their state pension has started, as state pension also counts towards the MIR threshold.

From a financial planning point of view, reaching the point where flexible drawdown could apply could be the gold standard to aim for, as it really does provide maximum flexibility when benefits are taken. Advice will be required if a client needs to transfer to another plan in order to access flexible drawdown. Advisers can rest assured that advice will be required on any remaining pension funds as well as funds that have been withdrawn, as clients will need advice on where to invest their additional cash.

With clients looking for increasing flexibility and more baby boomers approaching retirement (many benefiting from final salary pension schemes) surely flexible drawdown is a product whose time has come?

Flexible drawdown is available through the Aegon SIPP product wrapper on our Aegon Retirement Choices platform and through One Retirement. 

Phillip Hurst, Technical Development Manager, Aegon

Retirement