Contractors can cut the tax take on pension funds
Income drawdown is increasingly being used to offer a flexible alternative to the traditional annuity option - and can help keep more of your pension safe from the taxman because you get to keep some of your funds invested whilst you draw an income, writes Tony Harris of Contractor Money, an independent financial adviser to contractors.
No longer limited
This allows room for your nest egg and the income it produces to continue to grow. Moreover, under the new rules introduced in April this year, contractors have even greater say over how their retirement income is managed. These changes will help even more contractors to enjoy the flexibility of income drawdown as it is no longer limited to those with the largest pension pots.
But it is important to bear in mind that there is a risk associated with leaving your pension invested as it may be susceptible to volatility in, for instance, the stock market. In order to lower the risk associated with these fluctuations, contractors should look to draw income from less risky assets, such as cash, and leave equity funds to benefit from long term growth.
Preserve wealth for Contractor Junior
Crucially though, unlike the money used to buy an annuity that does NOT form part of your estate when you die, pensioners in drawdown pass on their fund to dependents minus a tax charge. In this way, contractors can preserve more of their wealth as the pension can be used to pass funds down to their next generation.
And if you are more concerned about what will happen to your pension pot when you pass away, then Phased Income Drawdown may be an even better option for you. It is ideally suited to those contractors who are aged under 75 and who don’t have a need for the full tax free lump sum. Put simply, phased drawdown allows you to release less income now, so that your dependents are entitled to more of your pension when you die.
Your dependents will receive more of your pension fund because you only move part of your fund into a drawdown plan; the rest remains invested in a personal pension which is protected in trust. Any money left untouched in the personal pension when you die will be paid as a lump sum to your dependents without any inheritance tax being taken - and the tax charge only falls upon the money in drawdown, so it provides a very tax efficient way of transferring savings to your loved ones.
Flexible drawdown enables those with a minimum £20,000 a year in income from a scheme, such as the civil service pension, to then draw the money as cash lump sums from any additional pension pots they may have. Subject to a tax charge this is a means of retirees unlocking potentially massive sums from the rigid constraint of a pension. In reality though, it is rare for contractors to have the guaranteed £20,000 income from a suitably guaranteed source.
Flexible but consider drawbacks
If you can opt for income drawdown when you retire then you will enjoy far more flexibility than your peers with an annuity. The extra good news is that you can always change your plans if you no longer wish to manage your own retirement fund. Contractors can switch to an annuity arrangement at any time if you feel that you would prefer to have a set income for the rest of your life. However, you will need to bear in mind that if you buy an annuity at a later stage, you may then have less in your pot to purchase one than if you buy one at age 65. Also remember that rates will normally be worse the older you are.
When in doubt…
It is important to consider how you will manage your income and whether or not you will carry on working past retirement age when deciding on whether to opt for income drawdown. It can be difficult to determine the best route to suit your individual circumstances but a contractor specialist pension adviser should be able to help you choose the right path.