Investors Chronicle has had a flurry of letters from readers confused about flexible drawdown - a rule that lets you take unlimited amounts of income from your self-invested personal pension (Sipp) if you've got £20,000 or more in guaranteed retirement income. So when Sipp providers told us they've seen a recent surge in people using it to get to their retirement funds, we weren't that surprised.
What we are concerned about, though, is discovering a general lack of understanding of the rules - not just among investors but regulated financial advisers too. This article is our attempt to set straight some of the myths so you don't accidentally slip up.
Myth: You need £20,000 a year of inflation-linked guaranteed pension income to qualify.
Truth: You need £20,000 a year in guaranteed pension income starting in the year you first apply. Even though your income will be devalued over time if you have a flat benefit (such as a level annuity), it will still qualify.
John Carson, a 62-year-old management consultant from Cheshire, emailed us because his financial adviser told him he needed inflation-linked benefits to qualify for flexible drawdown, which he is planning on using when he retires in around three years' time. But the savvy investor had been reading up on flexible drawdown and didn't remember reading anything in Investors Chronicle outlining this.
We called his FCA-regulated financial adviser who told us that "because the buying power of a level annuity is damaged by inflation over time", Mr Carson would need benefits linked to a moderate level of inflation to be accepted into a flexible drawdown plan.
But this is wrong. An investor of the same age and gender as Mr Carson who followed this advice would waste around £303,700 of his retirement fund buying an inflation-linked annuity. A single life level annuity worth £20,000 a year would cost him £352,300 (Canada Life) whereas an RPI inflation linked annuity for the same amount (which he would not need) would cost him £656,000 (Canada Life).
A spokesperson from HM Revenue & Customs said: "The £20,000 limit is not linked to any measure of inflation. When the government introduced flexible drawdown it proposed that the level of the limit should be set by Treasury at least every five years. This provides certainty for individuals currently saving while also allowing the level to be adjusted periodically." We asked the financial adviser to comment on having given wrong advice but he did not return our calls.
Myth: Once in flexible drawdown you can carry on working and not have to worry about it affecting the arrangement.
Truth: If your employer auto-enrolls you into a pension scheme you could face a 70 per cent tax bill.
Flexible drawdown rules forbid savers from adding to their pension pots in the same year as they drawdown, meaning accidental contributions made through workplace schemes will eliminate drawdown as an option in that tax year.
And pensioners already in flexible drawdown will face a 70 per cent levy on all payments exceeding the capped drawdown limits (£5,300 per £100,000), which could amount to thousands being lost unnecessarily.
However, retirees working part-time and earning over £8,105 a year will be automatically enrolled into a workplace pension scheme at some point over the next five years, with only one month to opt out due to the recently introduced rules. Part-time consultants and other high earners are particularly at risk, as they would only have to work a few hours a week to exceed the auto-enrolment threshold.
To opt out of auto-enrolment, you need to inform your employer, who will complete the process for you.
Myth: Flexible drawdown is only a good idea for people reaching or exceeding the lifetime allowance.
Truth: A growing number of investors are using flexible drawdown to free small to medium chunks of money from their Sipp.
To reach the lifetime allowance you would have to have considerably more than £20,000 in guaranteed pension income. But Adrian Walker, retirement planning manager at Skandia, is working with a number of clients who retired some time ago with secure pension income, but have smaller pots of savings (worth several thousand pounds) that they have left untouched. These are people who didn't want to use it to secure an annuity, and found that the levels of income available under capped drawdown were not attractive enough for them to consider. So they'd rather have a lump sum.
By going into flexible drawdown they can rid themselves of the small remaining pension pot to provide a one-off income stream. Typically, Sipps will charge a small fee to remove all funding from a flexible drawdown fund (for example, Hargreaves Landsdown charges £295), but some offer the service for free over a certain limit (Skandia doesn't charge for amounts over £50,000.)
