An opportunity to potentially improve tax-efficiency
rawdown is the main alternative to a secure annuity income. It is more flexible than an annuity but is also more complex and higher risk. Figures from Skandia (08 July 2013) show only one third (35 per cent) of people in drawdown are actually taking their full income allowance.
This means two thirds (65 per cent) of people with money purchase pension savings have the opportunity to potentially improve their tax-efficiency, and hence their overall long-term wealth. This can be achieved by opting to use some or all of their available pension income to build new untouched pension savings.
Qualify for tax relief
Individuals under 75 can currently achieve tax relief on contributions into a pension of up to £3,600 each year, even if they are not working. If someone is working they will qualify for tax relief on further contributions, subject to the annual contribution allowance and the level of their earnings.
New pension savings
Using the pension income to invest into new pension savings can have many benefits and no real downside. The income tax paid when money is taken from the existing pension is offset by the tax relief received when it is invested as new pension savings.
Future retirement income
Utilising unused drawdown income in this way, the new pension fund is not deemed to be ‘in drawdown’ and is not subject to the 55 per cent tax liability on lump sums paid to beneficiaries on death before age 75. The newly created pension fund will provide a further 25 per cent tax-free lump sum as part of their future retirement income (provided the savings are within the Lifetime Allowance).
For those in drawdown who have taken their tax-free lump sum but are not using all of their available income to improve the tax-efficiency of those savings with no real cost to themselves, not only does this planning reduce the potential tax liability for their beneficiaries on any available lump sum if they die before 75, it will also build another 25 per cent tax-free lump sum, helping to provide greater income in the longer term. This is good news for appropriate pensioners who may not be taking the maximum income allowance each year to build a more effective retirement income strategy.
Drawdown is a complex product. If you are at all uncertain about its suitability for your circumstances, you should seek professional financial advice. Your income is not secure. You control and must review where your pension is invested, and how much income you draw. Poor investment performance and excessive income withdrawals could deplete the fund.