Income drawdown: Why flexibility is more important than ever

Iain Herbertson, managing director of City Trustees, explains the benefits of flexible drawdown.

Much has been written about the new pension legislation, particularly flexible drawdown in recent months, which is an exciting addition. Retirement planning has always been an area where sophisticated in-depth financial planning makes a significant difference to clients, especially focusing on the income planning, the tax efficiency of that income and meeting the retired lifestyle objectives, which have become more and more, demanding.

IFAs and wealth managers have really focused in on this profitable market sector in recent years, with this baby boomer demographic holding a significant part of the nation’s wealth. This will continue to be the predominant market for IFAs and specialist pensions providers post RDR, especially with the introduction of the new pension legislation.

Our view is flexible drawdown can play a significant part and facilitate highly tax efficient income strategies as well as maximising lump sum death benefits providing strong annual fee charging opportunities for advisers who have RDR ready business models. It will also provide the opportunity for them to work closely with other professional advisers such as accountants and solicitors on these two subjects leading into further planning opportunities such as inheritance tax planning.

Benefit phasing

Where we see the most efficient use of flexible drawdown when the minimum income requirement can be met, is the phasing of benefits, which has always been a largely underused concept, but is now even much more efficient than previously as a result of the new legislation.

Once the minimum income requirement has been met, the client can take out a specified level of required income to top this up. An example to demonstrate this would be a client who has no need for an initial tax-free lump sum and has a SIPP with an un-crystallised value of £600,000.

The client is able to meet the minimum income requirement via a mixture state pension, guaranteed annuity and defined benefit scheme income. If they had a target income of £60,000 then £40,000 would be required to meet the desired income. Therefore if £40,000 were to be crystallised each year from the SIPP, £10,000 of which would be tax free and the balance subject to the client’s marginal rate, providing tax efficient means of extracting the income.

This strategy has the added advantage of leaving the remainder of the fund un-crystallised maximising tax-free lump sum death benefits prior to age 75. This exercise can be repeated each year and amended to suit the client’s requirements.

This type of planning lends itself perfectly to RDR ready business models and is an area where IFA practices can make significant differences to their clients and link in with their professional advisers.

Flexible drawdown does open up a wider debate regarding products and the access to these products that advisers will require to be able to provide this type of sophisticated financial planning. Few providers are currently able to offer flexible drawdown; some due to system build requirements, others over concerns of Royal Ascent and some providers have been questioned if it is in their interests due to their business models and funds under management charging structures.

Having looked at where flexible drawdown may be most effective for larger funds, it is not just larger funds where financial planning may benefit from flexible drawdown. Clients, who may have large amounts of defined benefit service, for example long serving public service employees able to meet the minimum income requirement with these retirement benefits alone.

It is not uncommon for them to have built up additional voluntary contributions (AVC) benefits alongside these schemes. There may be a planning opportunity for these clients who may not need the income from these benefits and may require access to help their children fund grandchildren’s education, especially with the significant changes to university funding. It is unlikely that the AVC provider will offer flexible drawdown within its terms and conditions.

Therefore this area of advice and planning will again lend itself to fee-based advice and will need the use of a transactional-based pension providers to facilitate the release of the funds as no commission will be paid and there will be no funds to manage.