Phased drawdown - Your flexible friend
Phased drawdown may sound like one of those terms made up to deliberately baffle the man or woman in the street.
But don't let that put you off. Phased drawdown is a valuable tool which can give people tax efficient flexibility in the way they use their pension pots in retirement.
However, while it's not highly complicated, the rules do need some explanation, which we'll provide through a series of real life client case studies over a series of forthcoming articles.
Take our client Paul. Paul had a successful career, serving as a chief executive for a number of different companies, building up several different types of pension schemes. He is also expecting to receive an inheritance.
He is now 63, married with children. His wife has minimal assets. He retired aged 58 and plans to use his state pension and one of his private schemes when he reaches the relevant retirement age. He continually reviews theses arrangements and may, in the future seek specialist advice as to whether he should think about transferring funds from one type of scheme into another (taking into account his health, financial situation and the market) - knowing the benefits and risks.
His current plan, following discussion with us, is to use one of his pension pots, worth £500,000, in the most tax efficient way to provide him and his family with their required income of £40,000 a year.
It's worth emphasising here just how important it is in retirement planning to remember the different between income before tax and after tax. The income Paul needs is £40,000 net of tax. If you forget that, you will either have to settle for a lower standard of living, or take more money from your pension that you planned and deplete it faster. It sounds obvious, but a surprising number of people overlook it.
As a first step, Paul took £120,000 of the £500,000, leaving £380,000 in his personal pension pot. That £380,000 stays outside the estate for inheritance tax purposes and is not liable to income tax or capital gains tax, so it is important to preserve that for as long as possible.
Of the £120,000 the rules allowed him to take up to 25% as a tax free lump sum. So Paul duly took £30,000 tax free cash which left him with the £90,000 in this second pot of drawdown money. Paul also had unused personal income tax allowance of £11,850 which he could add to the £30,000, giving him tax free income for the year of £41,850.
In the second year we did an exercise to see what money he needed, as he didn't spend all the money he took out in year one. In the event, he again drew his £11,850 tax free personal allowance from the pot of drawdown money. That year, he needed a further £20,000, so he took a further £80,000 from his pension pot, of which he took his 25% tax free lump sum of £20,000, giving him an income of £31,850.
In this way, the drawdown pot gets topped up and keeps growing. The personal pension will be depleted as you draw more than it grows, until, eventually you are only left with the drawdown pot, from which the only way of taking tax free money is your £11,850 personal income tax allowance.
On our models, someone aged 57 with a £400,000 pot could withdraw a tax-free income of £21,850 for 10 years, (assuming the investment keeps in pace with inflation). They could draw down 10% of their tax-free cash per year (£10,000) and withdraw the personal income allowance from their drawdown element (£11,850). This would leave the remaining £181,500 in drawdown that could provide further income for the client - however it would be taxable. They would then also be eligible for the state pension at 67.
*Based on current personal pension income allowance (August 2018)
Sadly, some people don't live to 67, but, with a drawdown arrangement, they will have left the maximum pot possible for their family, which will not be subject to inheritance tax.
Through regular reviews, Paul can extend the life of his pension scheme and, by prudent use of the tools available, minimise his tax liability. His strategy is to spend this pension scheme in the early years of his retirement, secure in the knowledge he has his second scheme coming on stream later, which he may bring into the same mechanism. Please be aware that a transfer from a Defined Benefit Scheme may not be possible within 12 months of the normal retirement date, or after the normal retirement date.
Paul's case demonstrates the advantages of phased drawdown. It brings flexibility in what you take and when you take it. You don't have to take the full 25%. So, if you overspend, you can make adjustments, and, if you underspend, your money is secure in a protected tax-free environment and you have preserved it for your family and dependents.
Everybody's circumstances are different, but it's possible that some form of phased drawdown would help you to fulfil your retirement ambitions. We'd be happy to discuss it with you.
Some of the issues are complicated, please seek financial advice. It is important that no actions should be taken without first taking advice. Personal circumstances and an individual's appetite for risk means that the advice for one person may not be the same for everyone. The information in this blog or any response to comments should not be regarded as financial advice. Reeves do not advise on Defined Benefit pension schemes. Reeves do introduce a third party specialists in areas of work we do not cover. Please note: This article has been published with the use of a fictional character to outline a case study.