It has been over two years since flexible drawdown was introduced but the take-up of this method of obtaining retirement income has so far been low. Is flexible drawdown just for the very wealthy or does the product have a future in the wider market?
Since April 2011, flexible drawdown allows unlimited income to be drawn from pension funds without reference to the Government Actuary Department’s rates which restrict the income that can be taken from capped drawdown or gilt yields that determine annuity rates.
To deter everyone from raiding their pension funds and leaving no income for retirement, rules are in place which determine eligibility for this form of drawdown and how it is taxed.
To qualify for flexible drawdown, people must have a minimum secure pension income of £20,000 a year in addition to their drawdown pension. This must be derived from one or a combination of the state pension, a company pension and a lifetime annuity.
Barnett Waddingham head of Sipp business development Andy Leggett believes this requirement makes flexible drawdown a niche product.
“The size of the average pension fund across the country is still only £30,000 so Joe Average is a long way off having this due to the income requirement. For those that are in a position to save significant sums for retirement, there are certain characteristics of flexible drawdown that make it potentially very attractive.”
One area where St James’s Place director of pensions Ian Price sees a role for flexible drawdown is among older people with final-salary schemes. “We’ve seen people with big final-salary schemes use flexible drawdown to take money out of additional voluntary contributions funds. They pay income tax on it but it enables them to access the money and plan with it or use it how they want.”
But with final-salary schemes becoming a thing of the past, flexible drawdown could increasingly be an option for more than just the top end of the pensions market.
LV= head of retirement distribution Steve Lewis says: “Industry figures indicate that there are more than 200,000 people who meet the minimum income requirement and have defined contribution pension schemes, with teachers among those likely to fit the criteria.”
He says the minimum income requirement may sound high but many people could qualify, especially if they have saved into a mixture of pension arrangements.
Partnership head of product development Mark Stopard agrees. He says: “While at first glance these products may seem most appropriate for the wealthy, people who have used a variety of vehicles to save for retirement can benefit from them as well.
“If they also had significant assets in other tax wrappers such as Isas, then there would be real scope for highly personalised planning strategies using the flexibility of drawdown to the best advantage. This is not an uncommon customer profile at the moment as there are a significant number of people who are retiring with both defined contribution and defined benefit pots.”
Stopard says flexible drawdown can also be attractive to someone who qualifies for an enhanced annuity as it will allow them to have a withdrawal rate more appropriate to their personal life expectancy.
But Rowanmoor Group head of pensions technical services Robert Graves says the level of pensions assets needed to meet the minimum income requirement rules out flexible drawdown as an option for most people.
He says: “If you look at a traditional case of someone retiring at 65 who is looking to take flexible drawdown and receiving the average state pension of £6,448, they would need to secure around £13,500 a year in pension income so would need a fund of around £225,000. If you take into account that you would want to have taken 25 per cent tax- free cash out of your pension fund, you are really looking at about £300,000.”
Graves also highlights the irony that some people will buy inflexible annuities to meet the requirements for gaining greater flexibility through flexible drawdown. He says people who want to secure their minimum income through an inflation-proofed annuity or one which provides an ongoing pension to a spouse need an even bigger pension pot.
“Even allowing for a state pension at 65, if you’re looking for a better annuity, you would need around £490,000 to meet the income requirements. But it’s a no-brainer situation if you already meet the qualifications or if you had a secured income of £18,000 a year, buying the extra £2,000 through an annuity might be worth it.
“You don’t have the three years capped drawdown reviews, so that is a cost saving, and you haven’t got to worry about GAD rates,” says Graves.
The low number of people taking flexible drawdown had raised concerns that if it was seen as a method for a small number of people to empty their pension savings, then it would be closed down.
But Legget says although the number of people who have used flexible drawdown is small, enough people have used it to prove these fears are unfounded.
“There was the fear that people would empty their funds and raid all their money at once but the number of people who have done this is extremely low. People haven’t used total flexibility to ransack heir pension funds.”
Part of the reason may be that income taken from flexible drawdown is subject to income tax as bigger withdrawals could attract the 40 per cent higher rate or 45 per cent additional rate of income tax.
Graves says: “If you are already receiving £20,000 pension income a year, you can only draw a further £22,000 a year if you want to avoid the higher rate income tax threshold. Another problem is that when you move into drawdown you take the money into a potential 55 per cent death benefit charge, but if you draw a substantial sum under drawdown and die without putting it into suitable inheritance tax shelter you potentially pay 40 per cent inheritance tax.”
Graves feels it is better to leave any money that is not needed as income in the pension where it can still benefit from tax-free growth, unless there is a specific reason to make a withdrawal. Otherwise, he believes clients could be putting themselves in a worse tax position. “If there is a wholesale review of drawdown and people can access their pension money, there could be no need for flexible drawdown in the future. But as it stands, it is of relatively limited use because of the size of the pension fund people need,” he says.