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This involves you taking up to 25 per cent of your fund as tax free cash whilst leaving the remainder of your pension fund invested. You can take income as and when you need it, subject to certain Inland Revenue limits however you are not obliged to take income each year. Following the recent changes to Pension Law, you are no longer obliged to buy an annuity at age 75.
- Flexible Income - each year you may vary the amount of income taken. You can also specify it be taken monthly, quarterly, half yearly or annually.
- Manage Your Investments - there is a greater range of options available if the unsecured pension is set up through a self invested personal pension or Sipp.
- Death Benefits Options - unlike annuities, draw down offers a choice of death benefits.
You give up control of your pension fund when you buy an annuity in return for a secure income. An unsecured pension is a much more risk involved option as your income will not be secure.
There are a number of risks involved when you defer an annuity purchase by investing in an income draw down plan. Understanding and knowing how to manage these risks is very important.
- Investment Risk – the value of your investments can go down as well as up
- Mortality Drag - if you defer purchasing an annuity, you will miss out on the mortality cross subsidy. The extra return required to compensate for the absence of this subsidy is called mortality drag.
- Decrease in your annuity purchasing power – If annuity rates fall and the value of your pension fund does not increase sufficiently to compensate, an annuity purchased in later years will provide less income compared to purchasing an annuity now.
The amount of income that can be paid from an Unsecured Pension fund is determined by reference to tables produced by the Government Actuary's Department (GAD). To ensure that the income limits from draw down are in line with annuities, the limits are calculated by reference to current gilt yields. GAD produces a set of special tables based on a range of interest rates.
There is a compulsory review of unsecured pension arrangements every three years to ensure that the pension fund can sustain future income payments. At the review, the minimum and maximum income limits are set for the next three years.
The more flexible death benefits is one of the most attractive features of draw down. Conversely, the most negative part of an annuity is the absence of any lump death benefit (unless you have purchased a joint life, guaranteed or money back annuity). On the death of the policyholder before age 75 there are three options:
- Take a lump sum death benefit - a surviving spouse or dependant may take the remaining pension fund as a capital sum, less a 55 per cent tax charge. The lump sum payment will be free of IHT, providing the correct trust has been set up.
- Continued taking unsecured pension - a surviving spouse or dependant may continue taking income withdrawals.
- Annuity Purchase - a single life annuity can be purchased for the spouse or dependant.
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