Tailored drawdown example
The best way to see if tailored drawdown works for your clients is to compare it against other income options.
In the following example (based on UK income tax rates), your client wants £20,000 a year after tax and has a pension pot of £400,000 to support this.
They have a personal allowance of £12,570 (in the tax year 2023/24) and no other taxable income.
|Income tax paid
|Tax-free lump sum entitlement used
|Personal allowance used
|1. Tailored drawdown
|2. Full drawdown
3. 100% tax-free lump sum
If your client lives in Scotland, the bands and rates of tax they'll pay will be different.
Option 1: Tailored drawdown
With tailored drawdown, we can pay your client any combination of tax-free and taxable income, within legislative limits as a regular income
This means we can pay £7,430 tax-free and £12,570 taxable – and no income tax is paid as this is within the personal annual allowance.
You can then demonstrate a saving to your client, and the value of regular advice in retirement.
Tailored drawdown can also replicate the tax-free lump sum-only or uncrystallised funds pension lump sums (UFPLS) payments if this is what the client requires, and this is a regular income stream.
Option 2: Full drawdown
Your client could take their full tax-free lump sum entitlement, put it in the bank and take a taxable income with the balance.
But this may rarely be the most tax-efficient method of accessing pension savings. That's because it could result in the payment of unnecessary income tax and could bring the tax-free lump sum into the estate for inheritance tax purposes.
Option 3: 100% tax-free lump sum
Your client could opt to take an annual income of £20,000 made up purely of tax-free lump sum. They wouldn't pay any income tax – but this then eats into the tax-free lump sum that can be taken at a later date.
Option 4: UFPLS
Your client could take regular uncrystallised funds pension lump sums (UFPLS) – with 25% as tax-free and 75% as taxable income.
If they want £20,000 a year after tax, they'd have to crystallise almost £21,000 – meaning their pension pot will reduce by more and they'll have less to draw on at a later date.
Points to note before moving into drawdown
As taxable income must be paid from the drawdown pot , we need this part of the pension plan to be sufficiently funded before we can pay a regular taxable income.
If it's the first time your client has taken money from their plan, the first income instruction must be entirely made up of tax-free lump sum entitlement.
For example, if a client wants £1,000 tax-free and £1,000 taxable income each month, the following would happen:
1. The first income paid will be £2,000 tax-free
2. This funds the post pension pot with £6,000 (75% of the total £8,000 crystallisation)
3. Income is then paid as £1,000 tax-free and £1,000 taxable each month
If your client takes a tax-free lump sum at the outset, there's no need to take the first instalment of tailored drawdown as 100% tax-free. This is because the lump sum will fund the post pension pot.