OUR DRAWDOWN SERVICES
Contributed by SIPP Specialists Limited
08 April, 2014
We have been asked to set out the Drawdown Services we can provide to Advisers and their clients. This is not meant to be a detailed technical breakdown of all the options, pros and cons, but we do have a detailed technical leaflet which provides all this should you require it.
When can benefits be taken?
Benefits can be taken from a SIPP at any time after age 55. However there is no compulsion to take benefits at this or any later age.
How much can be taken as a tax free lump sum?
It is possible to take up to 25% of the fund tax free. This is called a Pension Commencement Lump Sum (PCLS). When benefits are taken, including PCLS, this is classed as a Benefit Crystallisation Event
What about the rest of the fund?
The balance of the fund is used to provide taxable income over the remainder of the members lifetime. There are major changes coming into force from 6th April 2015.
What are the options prior to 6th April 2015?
There are 3 options:
- the member can keep the SIPP going, investing the assets accordingly, taking income each year out of the SIPP assets (either via Capped or Phased Drawdown), or
- provided the member has guaranteed minimum pension income (see later) of at least £12,000 per annum, they can opt for Flexible Drawdown and take as much income as they like from their SIPP, or
- an annuity can be purchased
An annuity can be purchased at any time so this means that the member can start to take benefits via income drawdown and then an annuity can be purchased at a later date. But note that once an annuity has been bought it cannot be unbought it is a one way option.
How does Capped Drawdown work?
The member chooses the level of income each year within the following ranges:
- nothing i.e. no income at all, and
- 150% of the income they would receive if the SIPP fund was applied to what are called GAD rates. These are published by the Government Actuarys Department (GAD) and are broadly the rates that would apply if the member was to buy an annuity. They depend on age and 15 year gilt rates.
So if the member takes a tax free cash sum and lives off that, they may decide to take zero income for a few years.
Note that if the member was in drawdown on 27th March 2014, they cannot opt for the new 150% of GAD level of income until they reach their pension review anniversary date after 27th March. So, for example, if someone last had a pension review as at 24th July 2012, their next 3 yearly review would not be due until 24th July 2015. However, from their next pension year date of 24th July 2014 they can opt to take 150% of GAD as income. They cannot however increase their maximum income before that date.
What is our fee for Capped Drawdown?
Our fee is £150 + VAT to do a review of the maximum pension available.
What is Phased Drawdown?
If the SIPP had a value of say £200,000, the member could choose to vest say half of it i.e. £100,000 and take £25,000 as a tax free lump sum. The other £75,000 would then be used for income drawdown and the residual £100,000 would be unvested.
After another year or two, the remaining £100,000 might have risen, with investment returns, to say £120,000. The member could then vest this £120,000 and take a further £30,000 tax free cash i.e. 25%, with the residual £90,000 being used for income drawdown. Under HMRC rules, when a second Benefit Crystallisation occurs, we as the SIPP Administrator have to recalculate, at that date, the new maximum drawdown pension that can be taken. This is done by adding together all crystallised funds and applying them to the current GAD rates.
This is called phased drawdown and can be a useful tool to take income, tax efficiently.
What is our fee for Phased Drawdown?
Our fee is £150 + VAT
What is Flexible Drawdown?
If the member has guaranteed pension income (effectively either from the State and/or an annuity and/or a guaranteed pension (e.g. from a Final Salary scheme) of at least £12,000 per annum, they can take as much pension via drawdown as they like in any year. They could even take the whole of their fund as drawdown income. We obviously need evidence of the guaranteed pension income.
Is the income taken under Flexible Drawdown taxed?
Yes, the income received under drawdown is subject to income tax at their marginal rate.
What is our fee for Flexible Drawdown?
Our fee is £250 + VAT
What are the proposals from 6th April 2015?
The 2014 Budget set out the principles that will apply, although the detail is still awaited. In principle, all the previous rules for drawdown disappear and everyone will be able to draw as much out at any time as they wish, but that income will be subject to their marginal rate of income tax. What we dont yet know though is whether this will apply to one and all from 6th April 2015 or whether people will have to wait until their first pension year anniversary after 6th April 2015. In essence, Flexible Drawdown will be available to everyone, but with no requirement for any guaranteed minimum pension income. Note that this option only applies to Defined Contribution schemes, not to Defined Benefit schemes.
An annuity option will still be available.
Advisors will need to carefully advise their clients on the tax implications of their drawdown options. For instance, some people may want to draw as much as they can whilst ensuring that their total income remains below the 40% tax band.
Inheritance tax will also need to be considered see below.
What happens on death in drawdown?
There are three choices:
- The remaining SIPP fund can be used to provide drawdown or to purchase an annuity for the surviving spouse and any other financial dependants, or
- 45% of the SIPP fund can be paid out to dependants or any other party as a lump sum. The other 55% is paid out as a tax charge.
- The remaining SIPP fund can be paid out to a pre-nominated charity, with no tax payable.
A combination of the above is possible e.g. 20% could be paid out tax free to a pre-nominated charity and 80% to dependants etc.
Post April 2015 advisors will need to carefully consider the IHT implications of their clients pension pots. Let us look at an extreme example to make the point. Consider the case of someone who is over 55 and in drawdown and who, without their pension assets, is comfortably over the IHT threshold. If they have a £1M pension fund, then they could draw it all out and pay 45% tax on it. Suppose that the next day they and their spouse are both killed in the proverbial car crash. The £550,000 that they have just received from their pension pot will go into their Estate and be subject to a further 40% IHT charge ie £220,000. So effectively they will have incurred a total tax charge of 67%. If the member had left the £1M in their pension fund, the tax would have been 55%.
Now consider someone with a more modest pension pot of say £100,000 whose other assets for IHT purposes are say £250,000.For the sake of simplicity let us assume that if they drew out the whole £100,000 they would pay tax on the whole £100,000 at 40% (in practice they would probably only pay tax at 20% on part of the £100,000). Then if they and their spouse were killed the next day in that proverbial car crash, the £60,000 net pension income would go into their Estate and as the total Estate of £310,000 was less than the IHT threshold, no further tax would be payable. If the member had left all the money in the pension fund, the tax payable would have been 55%.
So in one example, for death tax purposes, the pension should not be drawn out, whereas in the other case, the tax on death is lower if the monies are all taken out as pension income.
Depending on the precise details of the as yet unwritten legislation, advisors could have interesting times ahead.
What are the pros and cons of drawdown?
The SIPP is kept open and remains invested. So the IFA will need to give ongoing investment advice. The member draws income each year out of the assets of the SIPP. This means that the member retains total control of their SIPP fund.
There are some major advantages:
- Retaining control of the investments.
- The member can choose within a wide range the level of income each year (see below).
- The member also retains some control of capital on death, unlike an annuity
There are also some disadvantages:
- The SIPP assets may not be able to provide an adequate income level if the member lives a long time.
- If the value of investments within the SIPP falls in value, this may erode the fund and affect the amount of income the fund can generate.
- There are the regular ongoing administration costs of the SIPP.
- Mortality Drag.
How does an annuity work?
In essence, the whole or a part of the SIPP fund is passed to an insurance company and in return they will pay an annual income for the remainder of life. The level of income will be fixed each year (or will increase with an inflation adjustment if the annuity is purchased on that basis).
Income must be received each year, but the member can usually choose to receive it monthly, quarterly, half-yearly or yearly and it can be in advance i.e. it is paid at the start of the month, quarter or year etc., or in arrear i.e. at the end of the month, quarter or year.
Is the income payable under an annuity taxed?
Yes, the income from the annuity will be subject to income tax.
What is our fee for an annuity purchase?
Our fee is £300 + VAT
Do all SIPP Providers offer all options?
No. Quite a few do not offer Flexible Drawdown. However we offer all options.
Do we provide any technical support?
Whilst we cannot advise which option may be best for a client, we provide full technical support. This includes calculations, including what if calculations.
Please note there are significant risks associated with this decision and this can affect the value of future income. This document is for information only and should not be construed as advice.
« Go Back to Articles