Flexi-Access Drawdown remains a popular choice when deciding how to take benefits from a pension in retirement. Given the upcoming changes to pension legislation, where the value of an unused pension is included when assessing the value of an estate for Inheritance Tax (IHT) from April 2027, the added flexibility offered by a drawdown approach provides further planning opportunities for unused pension funds.
What is Flexi-Access Drawdown?
For those over the age of 55 (increasing to 57 from 2028) there are three methods of drawing a pension income from a personal or workplace pension. The first is to buy an annuity, where the residual pension fund after payment of Tax-Free Cash is used to purchase a guaranteed taxable income for life. The second option is to take ad hoc lump sums, which are usually drawn as part Tax Free Cash and the balance as taxable income.
The final option is Flexi-Access Drawdown. This is where the residual pension fund after Tax Free Cash remains invested and taxable income is drawn on a monthly, quarterly, annual, or ad hoc basis. Unlike an annuity, where the income remains unchanged (unless you choose an escalating annuity, which rises at a set percentage each year), Flexi-Access Drawdown allows you to control the precise amount of income that you draw. Income payments can be adjusted as required, and even suspended and restarted, to suit changes in circumstances.
The need to review existing pensions
Flexi-Access Drawdown is not offered by all pension arrangements. Whilst many newer pension contracts offer Flexi-Access Drawdown as an option, a surprising number of contracts, such as NEST (the workplace pension set up by the government) do not. When it comes to older style pension arrangements, these often pre-date the introduction of Pension Freedoms, and cannot facilitate drawdown.
It may, therefore, be necessary to transfer pensions to another provider that offers full access to pension flexibility; however, as there may be guarantees attaching to older style arrangements, such as guaranteed annuity rates or enhanced rates of Tax Free Cash that could be lost on transfer, it is important to seek independent advice before considering any pension consolidation exercise.
Why pension investment choices are critical
As pension funds remain invested through Flexi-Access Drawdown, a key component of any sensible plan is to ensure that pension investments remain appropriate, considering your financial objectives, needs, and individual circumstances, and continue to perform well compared to underlying market conditions. Even where pensions offer Flexi-Access Drawdown, the contract itself may only offer a limited range of fund options, which can hinder investment performance over time. This can be avoided by selecting a provider that offers funds from across the marketplace, from which an appropriate investment strategy can be constructed.
IHT and pensions
The flexibility of a Flexi-Access Drawdown approach can be a useful tool when dealing with unused pension funds, which become potentially liable to IHT in less than eighteen months’ time. Under the current rules, unused pension funds are exempt from IHT, and a mainstay of financial planning advice over recent years has been to consider personal pensions as a way of passing wealth to the next generation outside of your estate.
With the IHT treatment of unused pension funds changing from April 2027, existing financial plans may well need to adapt. One option may be to take pension drawdowns, which can fund gifts to family members. Where Tax Free Cash is available within an individual’s Lump Sum Allowance, this can be drawn without any income tax charge. Once Tax Free Cash has been exhausted, it may also be an option to draw regular income from a pension in drawdown, even if it is not needed to support your lifestyle, to fund further gifts to family. Whilst the drawdown income would be subject to Income Tax, depending on your total annual income, it is possible that this income could be drawn at Basic Rate (20%). Whilst it may seem counter-intuitive to volunteer to pay Income Tax, paying 20% Income Tax may well be preferable to your beneficiaries paying IHT at 40%.
It is also worth remembering that where an individual dies after the age of 75, beneficiaries will pay income tax at their marginal rate (i.e. added to their other income and taxed accordingly) on sums drawn from the pension in addition to the fund potentially being liable to IHT. Taking drawdown pension income to fund gifts could, therefore, prove to be tax-efficient, although this depends on your personal financial circumstances.
The benefit of independent advice
Flexi-Access Drawdown could be a sensible option to consider for those needing retirement income or wishing to pass funds to the next generation in a tax-efficient manner. It is, however, not the only option, and the benefit of a guaranteed income via an annuity may be appropriate for some. An alternative could be to blend these approaches to provide an element of guaranteed income together with the additional flexibility offered by Flexi-Access Drawdown.
This is where tailored advice is so valuable when planning for retirement and later life. Our experienced advisors can look across the marketplace and consider the most appropriate option, or options, for your circumstances. We can access pension plans that offer drawdown at competitive terms, and our truly independent approach to investment selection can help build an advisory or discretionary managed portfolio to meet your needs and objectives.
As investments remain in place through Flexi-Access Drawdown, it is important that any drawdown plan is carefully reviewed at regular intervals, to ensure that the strategy can adapt to changes in circumstances and further changes in legislation. Our comprehensive annual planning review takes a holistic approach by considering all aspects of your financial arrangements, and our advisers can recommend changes in strategy that may be required to meet changes in your circumstances and prevailing investment market conditions.
Speak to one of our independent advisers to discuss pension income options in retirement, or how best to deal with unused pensions given the upcoming changes to the IHT treatment of unused pensions on death.
