Advantages & Disadvantages of Pension Drawdown
Pension Drawdown - Advantages
- Cash equivalent transfer values are at an all time high (March 2017)
- Ability to take all of your tax-free cash lump sum entitlement at outset
- Flexibility to vary your income according to your requirements
- The individual can structure their income to mitigate the liability to personal Income Tax. By reducing their income in some years, they may be able to avoid higher rate tax liability.
- Control of your investment
- Funds could benefit from investment growth in a tax-efficient environment
- Choice not to purchase an annuity
- Potential death benefits may be greater than under the conventional annuities route.
- On the death of the member the remaining vested pension fund can be returned to the individual's beneficiaries and remain in pension drawdown, free from Inheritance Tax and Income Tax.
- The individual may be able to use a pension fund withdrawal as part of their Inheritance Tax planning by using varying levels of income, within prescribed limits, and using all or part of the income to make gifts to take advantage of annual exemptions.
- By entering into a drawdown you keep your options open - if your health deteriorates and you need to enter a care home - then you can decide to buy an impaired annuity, you will also be able to take advantage of other new products which come to the market.
- With an annuity you have to choose all your options at the start - eg whether to provide for a spouse, whether to link to inflation. It also does not take into account the fact that your health may deteriorate and that if you had waited you might have achieved a greater return through an enhanced or impaired annuity. You also have to specify your lump sum requirements at commencement, there is no flexibility later on once the annuity has started.
Pension Drawdown – Disadvantages
- Future investment returns are not guaranteed
- High withdrawals of income may not be sustainable
- The higher the level of income withdrawal chosen the less that may be available to provide for dependants
- Increased flexibility brings increased administration costs
- The level of income may change due to the reviews
- Income withdrawals may erode the value of the fund and therefore there may be a reduced fund that can be used to purchase an annuity in future years.
- Income Drawdown is a higher risk approach to pension income withdrawal than an annuity.
- Annuity rates may be at a worse level when annuity purchase takes place
- The Financial Conduct Authority (FCA) has particular concerns in relation to mortality risk. If you purchase an annuity, you may benefit from a cross-subsidy from those annuitants who die early. This cross-subsidy is not present in drawdown contracts, so to provide a comparable income, a higher investment return will be required.
- The charges are 'explicit' whereas under an annuity they are inherent in the annuity rate offered.
The value of investments and income from them may go down. You may not get back the original amount invested.
A pension is a long term investment. The fund value may fluctuate and can go down. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation.
Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from taxation, are subject to change.