Capped drawdown is basically a continuation of unsecured pension - a means of taking pension benefits without buying an annuity.

The basics of a capped drawdown contract are relatively simple. Just like an annuity you can take the tax-free cash from the pension, but rather than buying a fixed income with the remaining funds, you withdraw money from the contract.

Key points

• The maximum you can withdraw each year is about the same as a level annuity; e.g. £6,800 per £100,000 fund at age 65 (in May 2011)

• No income has to be take at all

• For most people you can start at age 55

• There is no upper age limit

• The upper income limit is reassessed every three years for those under 75, based on age and fund size

• The upper income limit is reassessed every year for those over 75, also based on age and fund size

• In the event of death the remaining fund can be be used by a dependent to continue to draw income, or buy an annuity, and can usually be paid out less tax at 55% (it used to be 35%)

• The fund can also be paid to a charity in the event of death and is not then taxed

The advantages of capped drawdown

• The tax-free lump sum can be taken

• Capped drawdown allows income to be varied subject to an annual maximum

• Capped drawdown permits you to just take the lump sum and no income if you want.

• Capped drawdown avoids buying an annuity completely - even beyond age 75

• You don’t have to decide on whether to include spouse’s benefits or other such options with a capped drawdown contract

• The fund can remain invested so it could grow further

• The future income could go up

• The fund can be passed on in the event of death

There are of course disadvantages to a drawdown plan:

• Annuity rates could go down, if you later decide you want to buy an annuity with your remaining funds

• The capped drawdown contract could fall in value

• The ongoing income is not guaranteed and could go down

• Capped drawdown requires ongoing monitoring of the plan

• Charges are higher for drawdown than annuity purchase

There is also a loss of the what is known as mortality cross subsidy which is gained through annuity purchase. This cross subsidy is the additional income you effectively receive when you buy an annuity, since the funds of people who die earlier than anticipated are in part used to provide income to those who live longer.

The main disadvantage is that the value of the fund may be eroded, especially if investment returns are poor and a high level of income is taken; this could result in a lower income in the future.

Capped drawdown - has restrictions on how much income can be withdrawn

Flexible drawdown - no restrictions on how much can be withdrawn, but only available if you have guaranteed income of £20,000 per year

If you have a question about pension drawdown or want to discuss Flexible or Capped drawdown in more detail and how it can benefit you then contact us online or phone 0800 011 2713.

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