“If only I could get my hands on my pension fund” Well guess what. You can!
Quite rightly, The Pensions Regulator is closing fraudulent pension liberation scams. However, when you reach 55, there’s a totally legal and HMRC approved method which allows you to draw out your whole pension fund.
Last week, you’ll see I ran a comparison between an Annuity and Income Drawdown. Today, I reveal a very interesting version of Income Drawdown called Flexible Drawdown.
You Can Literally Draw Out Your Pension Fund In One Go
Unlike Income Drawdown, where the level of income you can draw is broadly limited to an Annuity rate, Flexible Drawdown allows you to draw unlimited income. And if you want your whole fund, you can have it. So what’s the catch?
There isn’t one. But you do have to meet one rule. You have to have a guaranteed income of £20,000 per year. There’s a simple reason for this.
If you spend the whole of your pension fund so you’re left with nothing, there’s a good chance the State would have to support you. That wouldn’t be fair on other taxpayers. So having a minimum annual income of £20,000 not only means you’ll never be a burden on the State, it also ensures you’re always likely to be a basic rate tax payer.
The good news is that your guaranteed income can be made up in a number of ways:
- Your State Pension
- Final Salary Pensions
- Pension Annuities
- Scheme Pensions
If you want to learn more about this, HMRC has full details of Flexible Drawdown on its website.
It Can Be Very Tax Efficient
As you built your pension fund, you would have enjoyed tax relief at your highest rate of Income Tax. Whilst the highest rate of Income Tax today is 45%, in the past it was much higher. It was 60% for many years. What’s more, your money will have grown in a tax privileged way, compared to other investments.
The money you draw out from your pension fund as Flexible Drawdown is taxed just as it would be if you’d bought an Annuity. That is, as income. The maximum Income Tax you’d pay today is 45%, and then only on the taxable part of your income over £150,000.
If you plan your income withdrawals over a number of years, you could end up paying basic rate Income Tax on some if not all of your money. That’s just 20%. How good is that, considering you could have enjoyed 60% tax relief in the first place?
It Can Be Tax Efficient On Death Too
If you die when your pension is in Income Drawdown, there’s a 55% tax charge imposed on the fund. The Income Tax you’ll pay in withdrawing your fund could be significantly lower than this. As you’ve seen above, the top rate is currently 45% and you could pay as little as 20%. Those loved ones you leave behind could end up with a lot more money.
However, you do need to be mindful of Inheritance Tax, for if you simply add the withdrawals to your other assets, your Estate may suffer a second tax on the withdrawals.
An Innovative Use Of Flexible Drawdown
I was recently asked by Keith, a SIPPclub member, if there’s a way to enable part of his substantial pension fund to be made available for his two daughters.
Unfortunately, it isn’t possible to simply transfer the funds to his daughters, as Keith’s pension fund must always remain with him. Flexible Drawdown could be a solution.
To qualify for Flexible Drawdown, Keith could first top up his State Pension and small Final Salary pension to a guaranteed income of £20,000 per year by buying a relatively small annuity.
Having elected Flexible Drawdown, he could take annual withdrawals of £10,000 per year. Added to his other income, they would only be taxed at the basic rate. This would give him £8,000 after tax for his daughters.
Both of his daughters work and currently don’t have pensions. He could therefore contribute £4,000 to pensions for each them. And as pension contributions are paid net of basic rate tax, each daughter would have £5,000 invested in her pension when her provider reclaimed the tax from HMRC. That’s precisely the sum Keith will have drawn from his pension.
There is no Inheritance Tax implication, for the money is simply coming out of Keith’s pension and into his daughters' pensions, leaving the value of his Estate unchanged.
Interestingly, if the daughters pay tax at a higher rate, they could claim a tax rebate. It could be worth a further £1,000 or £1,250 to each of them, depending on their tax rate.
Now that is tax efficient.
It’s Not For Everyone
Because of the flexibility and the generous tax advantages, once you start Flexible Drawdown, that’s it as far as building a new pension fund is concerned. It’s a one-way ticket out of pensions for good, for you can’t make any new contributions and enjoy the tax privileges that come with them.
There’s no doubt that being able to access your pension fund could open up investment opportunities you didn’t think were possible. For example, Flexible Drawdown could enable you to access money for residential property investment, like buy-to-let. Currently, you can’t hold residential property of any sort within a SIPP.
By contrast, the biggest disadvantage with Flexible Drawdown can be summed up in the statement “you can’t have your cake and eat it too”.
If you draw out your fund from 55 onwards and live to a ripe old age, if you don’t invest the withdrawals wisely, chances are you’ll find yourself short of income in later life. And that could make Flexible Drawdown a really bad move.
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AJ Bell Is Often The Best Value SIPP For Stockmarket Assets
Over time, charges can wipe out a huge part of your fund. We like AJ Bell because there are no set-up costs. If you hold passive funds, which is our preference, or shares, investment trusts, EFTs, gilts or bonds, you pay one small fixed fee no matter how large your fund. And when you come to draw your benefits either as occasional drawdown or UFPLS payments, there's a small charge for the whole year no matter how many times you access your money (many SIPP and SSAS providers charge more than this for each payment). However, you should always compare charges in detail, because AJ Bell could be more expensive than other providers, depending on the type of stockmarket assets you hold.
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