Phased Income Drawdown
Phased drawdown is an option best suited to those under age 75, who want to take their pension benefits, and who do not require the full amount of tax-free cash available from their pension funds.
Phased drawdown can be particularly tax-efficient, both in terms of death benefits and in the money taken from the plan, and can work with both Capped and Flexible Drawdown.
How Phased Income Drawdown Works
Example: Mr Jones is 60, self-employed and is reducing the number of hours he works. He expects his income from employment to be £20,000 per year, and has no other taxable income. He wants to receive the equivalent of £5,000 per annum after tax to make up for the reduced earnings, but does not want to buy an annuity.
He has a pension fund of £200,000 and he has no need to take the tax-free lump sum available.
Full Income Drawdown
- Mr Jones takes £50,000 as a lump sum. The first problem he faces is where to put the money so that it is tax efficient, both in terms of Inheritance Tax, as it now forms part of his estate, and in terms of Income and Capital Gains Tax.
- The remaining £150,000 needs to provide an income of £5,000.
- To provide £5,000, after basic rate tax, requires a gross amount of £6,250.
- Therefore, he decides to take £6,250 from his pension fund to provide the income, which is then taxed at 20% (in his circumstances) which amounts to £1,250, giving him £5,000.
Death Benefits - Income Drawdown
In the event of Mr Jone's death, the drawdown fund can be paid out as a lump sum, less tax, at a rate of 55%. £150,000 after tax, at a rate of 55%, equals £67,500.
The tax-free cash of £50,000 he has already taken could be liable to Inheritance Tax at a rate of 40%, leaving only £30,000.
So in the worst case scenario, the pension fund of £200,000 could suffer tax of £102,500 if he takes the benefits in this way, and dies.
Please note that the value of the fund does not have to be taken as a lump sum - see unsecured pension for more details of the other death benefits.
Phased Income Drawdown
- As Mr Jones has no requirement for the lump sum, he opts for phased income drawdown
- To get £5,000 he only uses £18,000 of his pension
- He takes 25% of the £18,000 which gives him a lump sum of £4,500
- The remaining £13,500 is invested in a drawdown contract
- He then requires only £500 after tax to provide the £5,000 required
- To provide £500, after basic rate tax, requires a gross amount of £625
- So, to provide the £5,000 Mr Jones has only used £5,125 of his pension fund
- £4,500 is tax-free cash, and £625 is taxable income
- This process can be repeated until the tax-free cash is depleted
If Mr Jones were to die then his loved ones could receive the following:
£13,500 less tax at a rate of 55%, which amounts to £6,075.
The remaining pension pot of £182,000 is paid out without the deduction of tax, since it is held in a pension plan under trust. It does not form part of his estate, so, it is not instance, liable to Inheritance Tax.
The Phased Income drawdown route offers better death benefits in terms of a lump sum payment. A Phased drawdown contract is in effect two different plans, an unvested personal pension and a vested drawdown element. The death benefits from an unvested personal pension allow all the funds to be paid as a lump sum (assuming there are no protected rights) without the deduction of tax, and it is not normally liable to Inheritance Tax, as such plans are under trust. The vested element is able to be paid out, less tax at a rate of 55%.
The above example only shows one year, but there would be no reason why it could not continue, and as each year passed, take more tax-free cash and more income. In fact, there would not be any requirement to take any taxable income at all, and just a portion of the tax-free cash could be taken each year.
It is even possible that the amount of tax-free cash could grow, or perhaps fall. It would always be 25% of the unvested element, so if that grew in value, so would the amount of tax-free cash.
So if you don't need the lump sum, and you are considering drawdown, you might want to consider a Phased Income drawdown contract.
If you have a question about income drawdown or want to discuss Phased drawdown in more detail and how it can benefit you, then Contact us online or phone 0800 011 2713.
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