Pension income drawdown
This briefing looks at income drawdown which is one of the options for taking benefits from a pension. It covers flexi-access drawdown and includes details of older capped drawdown plans that are still in place. It also looks at beneficiary’s drawdown which can be paid following the member’s death.
- Income drawdown allows an individual to access all or part of their pension commencement lump sum (PCLS) – also known as tax free cash - whilst keeping the rest of their funds invested and taking an income from it as and when required.
- Flexi-access drawdown has been available since 6 April 2015. With flexi-access drawdown there is no requirement to take income and no minimum or maximum income withdrawal level.
- Existing capped drawdown plans can be maintained. Capped drawdown has limits on the level of annual income withdrawals. No new capped drawdown plans can be set up since 5 April 2015.
- Drawdown income is subject to income tax. It is paid by the pension scheme under PAYE.
- Taking income from Flexi-access drawdown will trigger the Money Purchase Annual Allowance (MPAA).
- On the death of the member, funds may be used to provide drawdown for a beneficiary.
- The basics of Income drawdown
- Existing capped drawdown plans
- Flexi-access drawdown
- The taxation of income drawdown
- Death benefits from Income drawdown
- Drawdown transfers
The basics of income drawdown
An individual can take income drawdown from any money purchase pension arrangement, provided the scheme allows. Some schemes may require a transfer to a different product or arrangement to access flexi access drawdown. Some older products may not offer drawdown and the member may need to transfer to another product or scheme to access it.
Since 6 April 2015 all new income drawdown plans are flexi-access drawdown. With flexi-access drawdown there is no limit on yearly income withdrawals.
Those who had existing capped drawdown arrangements on 6 April 2015 can continue them or convert to flexi-access drawdown. Capped drawdown has limits on how much income can be taken (see the capped drawdown section below).
Before 6 April 2015, there was a third form of drawdown – flexible drawdown. This had no income withdrawal limits but was only available to those who were already receiving at least a minimum level of secure retirement income. Anyone in flexible drawdown automatically converted to flexi-access drawdown on 6 April 2015.
From the Normal Minimum Retirement Age (NMPA) - currently 55 but increasing to 57 from 6 April 2028 - or earlier in the case of ill health or a protected pension age, a member can choose to designate all or part of the funds under their arrangement to provide income withdrawals through flexi-access drawdown.
Any benefits crystallised to provide income withdrawals are kept separate from any other uncrystallised benefits under the member’s arrangement. Where the member has any uncrystallised benefits remaining in an arrangement, further contributions may be paid to that arrangement.
There is no need to take an income each year if the member does not wish to do so.
Individuals don’t have to stay in drawdown, they can use the drawdown funds to buy an annuity at any time.
There are no special investment restrictions placed on a member’s drawdown pension fund.
Existing capped drawdown plans
Whilst no new capped drawdown plans can be set up post 6 April 2015, those who already have a capped drawdown arrangement may be able to designate further funds to it. At each designation, 25% of the value can be taken as tax-free pension commencement lump sum as long as there is sufficient lifetime allowance remaining.
The advantage of remaining in capped drawdown is that the MPAA is not triggered if income withdrawals stay within the limits. This would enable larger tax relievable contributions to pensions than would be available with using flexi-access drawdown. The disadvantage of capped drawdown is that the income available each year is restricted.
The maximum permitted income that can be taken each year from capped drawdown is 150% of a "relevant annuity", also known as the Government Actuary’s Department (GAD) basis amount. The “relevant annuity” is calculated using GAD tables published by HMRC, and provides a rate of income per £1,000 of drawdown fund based on the individual’s age attained and current long-term gilt yields.
The member can, subject to the rules of the scheme concerned, vary the amounts and timing of income payment taken each year within the maximum.
The maximum permitted income must be reviewed every three years before age 75 and every year thereafter. A more frequent review is not allowed unless one of the following three events occurs, or the member nominates a different review date:
- A lifetime annuity or a scheme pension is purchased with part of the member’s capped drawdown fund.
- Further monies are “designated” into an existing capped drawdown arrangement to provide additional income withdrawals.
- A member’s capped drawdown fund is reduced following a pension debit as a result of a pension sharing order.
If a member needs more income than is available from capped drawdown, they may be able to (if the scheme is able to administer it) choose to convert to flexi access drawdown. They may also look to transfer to another provider that can offer flexi access drawdown and convert the benefits as part of the transfer or once received.
Designating benefits to flexi access drawdown enables a member to draw income from their pension pot as and when it’s needed. Unlike an annuity there is no requirement to draw an income, and unlike capped drawdown there is no cap on how much can be drawn.
It is important to remember that designating to flexi access drawdown does not trigger the MPAA. The first income withdrawal from flexi-access drawdown will trigger the MPAA. Once triggered the MPAA will reduce the individual's annual allowance to £10,000 in respect of future contributions to defined contribution schemes.
Remember, any unused MPAA cannot be carried forward, and carry forward from previous years cannot be used to increase the MPAA.
However, if the individual only takes their tax free cash entitlement after designating their funds into drawdown but takes no income, they retain the standard annual allowance.
Anyone in flexible drawdown automatically converted to flexi-access drawdown at 6 April 2015, and the money purchase annual allowance was also triggered from the same date.
The taxation of income drawdown
Any income drawn by the member will be taxed at their marginal rates of income tax. It doesn’t matter if drawdown income is paid from benefits below the lifetime allowance, or benefits in excess of the lifetime allowance. The pension provider must make income payments under PAYE.
The member’s drawdown pension fund will continue to be invested in a tax privileged manner.
The tax treatment on death is described below.
Drawdown and Death benefits
Subject to scheme rules, the member’s residual drawdown pension fund on death can be used to provide:
- A drawdown pension fund lump sum death benefit;
- A beneficiary’s annuity;
- A beneficiary’s flexi-access drawdown.
Where a member dies in capped drawdown it is no longer possible for their beneficiary to continue in capped drawdown. Note that any dependants’ capped drawdown setup before 6 April 2015 can continue. If the beneficiary wishes to continue in drawdown, then their only option is flexi-access drawdown. However, there is no disadvantage in this as the MPAA is not triggered where income is taken from a beneficiary’s drawdown arrangement.
Beneficiaries may select to receive a beneficiary’s annuity or drawdown even if they have not reached the normal minimum pension age.
Drawdown death benefits will be paid tax-free if the member died under age 75 and benefits are designated to beneficiary’s drawdown within two years of the date when the scheme administrator was made aware of the death.
At age 75 or above, or if there is a delay of over two years from notification of death, benefits will be taxed as income on the recipient under PAYE except when it is paid to a non-qualifying person e.g. a trust, in which case a 45% tax charge will apply.
Drawdown death benefits will not be tested against the Lifetime Allowance as they were already tested when the member’s benefits were crystallised to provide the income withdrawals and again at age 75.
In normal circumstances there should be no inheritance tax (IHT) payable, though the IHT exemption relies on the scheme administrator having final discretion in the choice of beneficiary. The member can typically nominate who they wish to receive the death benefits.
If there are any surviving dependants of the member, beneficiary’s flexi-access drawdown or annuity can only be paid to a non-dependant if they have been nominated by the member, but there is no such restriction on lump sums.
If the member has no dependants at the time of death and has nominated a charity to receive death benefits, these can be paid to the charity without any tax charge.
If a dependant or nominee dies while receiving flexi-access drawdown, the remaining fund may be passed down to a successor, and this process can continue indefinitely. The tax position will depend on the age at death of the person who has just died.
All forms of drawdown funds can be transferred including beneficiary’s drawdown.
However, it's not possible to partially transfer drawdown funds, all drawdown funds under the arrangement must be transferred.
Any transferred drawdown funds must be held separately from any other funds the pensioner has under the receiving scheme i.e. they must be transferred to a new arrangement and can’t be added to existing funds.
Capped Drawdown funds retain their GAD limits and GAD review period on transfer, so details of these need to be provided to a receiving scheme.