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30/10/2013

Flexible drawdown at a glance

This at a glance article describes the requirements that need to be met to access flexible drawdown.

What is flexible drawdown?

Flexible drawdown is a type of income withdrawal where you can take pension income direct from your pension fund without having to purchase an annuity. Ordinarily there are limits on the maximum income you can take under income withdrawal (known as capped drawdown). However, under flexible drawdown there is no limit on the amount of income you can take in any year. You can tailor your drawdown pension to suit your personal requirements whether taking regular amounts at a set frequency or ad hoc income when required. There is even the option to draw the entire fund in one go.

All income withdrawal payments are subject to income tax under PAYE at your appropriate marginal rate.

To be able to use the flexible drawdown facility you must meet certain requirements.

What are the flexible drawdown requirements?

You must meet the following conditions:

  • You must be in receipt of ‘relevant pension income’ of at least £20,000 per year; and actually receive at least £20,000 relevant pension income in the tax year that you enter flexible drawdown.
  • You must not have made pension contributions to a money purchase arrangement (for example a personal pension) in the tax year that you go into flexible drawdown. This includes contributions made on your behalf by an employer or a third party.
  • You must have stopped building up benefits under a defined benefit or cash balance arrangement*.

To enter flexible drawdown you must make a valid flexible drawdown declaration and have that declaration accepted by the Scheme Administrator.

Note: Once you have entered flexible drawdown you will incur tax charges if you build up any subsequent pension benefits under any registered pension scheme.

What type of pension income counts as ‘relevant pension income’?

Relevant pension income includes:

State pensions – basic state pensions and state second pensions; state graduated pension; industrial death benefit; widowed mother’s allowance; widowed parent’s allowance; and state widow’s pension.

Scheme pensions – this is a type of pension that is normally provided by Final Salary (defined benefit) schemes. Not all scheme pensions count as relevant pension income, see note A below to see what counts.

Lifetime annuities – pension income purchased from an insurance company. Not all lifetime annuities count as relevant pension income, see note B below to see what counts.

Overseas pensions that would be one of the types of pension above if paid by a UK registered pension scheme.

Pension income provided by the Financial Assistance Scheme (FAS). The FAS provides compensation to members of pension schemes that ended and did not have enough money to pay member’s benefits.

Please note that income drawdown and fixed term annuities cannot count toward the £20,000 minimum income requirement.

Note A:

A scheme pension from a defined benefit arrangement will count as relevant income if the scheme it is paid by has 20 or more people who are in receipt of a pension. A scheme pension from a Money Purchase Arrangement will count as relevant income if the scheme it is paid by has 20 or more people who are in receipt of a scheme pension.

If there are less than 20 people receiving a pension, as previously described, it will not count as relevant income unless either of the following applies:

  • There were 20 or more members with defined benefits entitlements in the scheme before
    6 April 2011 and you were one of those members; or
  • The scheme pension you are receiving is met by an annuity contract provided by an insurance company.

Note B:

To count as relevant income a lifetime annuity must be either level or increase by a fixed rate, for example 3% a year, or one linked to RPI.

For all other lifetime annuities it is only the amount guaranteed to be paid each year that can be included for relevant income purposes, regardless of any increase or decrease that may apply to the annuity year on year.

The scheme providing your pension income will be able to confirm which of the above circumstances applies to you.

What happens if it is subsequently found that the flexible drawdown conditions have not been met?

This will depend on what payments have been made from the drawdown fund. If the conditions were not met, the income withdrawal payments will be subject to maximum annual income limits that apply to capped drawdown.

If the income withdrawal payments made exceed the maximum amount allowed under capped drawdown, the amount of the excess income withdrawal payment will be subject to unauthorised payment tax charges payable to HM Revenue & Customs. The tax charge can be up to 70% of the excess income withdrawal payment (net of any income tax already applied to the excess withdrawal payment).

*A cash balance arrangement provides a lump sum that is added to your pension pot for each year of service and sometimes a promise that your fund value will increase each year by at least a set rate. When you draw a pension, the benefit payable will depend on the fund value at that time. For example you are promised that £5,000 will be added to your pension pot for every year with your employer. So if you are with your employer for 20 years you can expect a pension pot of £100,000. But you don't know how much pension £100,000 will buy as that will depend on annuity rates when you start to draw a pension.

This article is based on Skandia’s interpretation of the law and HM Revenue & Customs practice as at October 2012. We believe this interpretation to be correct, but cannot guarantee it. Tax relief and the tax treatment of investment funds may change.

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