Choosing The Right Option At Retirement – Capped Income Drawdown (Part 1)

Choosing The Right Option At Retirement

In previous articles in this series, we have introduced some of the considerations that one faces when approaching retirement, and some of the options in the form of annuities, investment-linked annuities and most recently phased retirement. Here we take a look at Capped Income Drawdown

The concept is not new, with the original, legislative foundations for previous incarnations, known as Income Drawdown and Unsecured Pension (USP), being founded within the Finance Act 1995.

Firstly let us answer the question ‘What is Capped Income Drawdown?’ Simply put, it is an option available at retirement, either in the form of a stand-alone plan or more frequently nowadays as a feature within many flexible personal pension plans. When an individual moves or transfers into Capped Income Drawdown, rather than being utilised to purchase an income through an annuity, their accumulated pension fund remains invested and income is provided via a series of encashments from the fund. The current rules governing this came into effect 6th April 2011 and apply not only to new plans but also to existing drawdown arrangements already in place.

Once a decision has been made whether to take the pension commencement lump sum (tax-free cash) or not, a maximum level of income will be calculated. This will be based upon age, sex (at least until unisex rates come into being as a result of the European Directive on Sex Discrimination in December 2012), the prevailing long-dated gilt yield and of course the value of the residual fund. This will broadly be equivalent to 100% of the comparable annuity, and is based upon Government Actuary Department (GAD) rate tables. Income levels may be set at any point between nil and this calculated maximum and changed at any time. The GAD limit will be recalculated every 3 years based upon the fund remaining and the factors noted above.

So what is different between the old rules and those that currently apply?

  • Capped Income Drawdown may now be continued beyond age 75 with compulsory annuitisation now abolished.
  • Maximum income is now 100% of the GAD limit, whereas previously 120% was permitted. This has been reduced with a view to ensuring clients draw a more sustainable level of income.
  • The review periods are every 3 years, rather than every 5 years, or sooner if required.
  • The tax charge upon lump sum death benefits whilst in capped drawdown prior to the age of 75 has been increased from 35% to 55%.

Whilst triennial reviews of these plans are required as far as GAD limits are concerned, it is strongly recommended that they be reviewed each year with regard to the underlying investment. As with all investments, due consideration should be given to the fund performance and asset allocation. This not only ensures these are adequate and in keeping with one’s attitude and tolerance to investment risk but also allows one to monitor the progression against the required critical yields.

In part 2 of this subject, we will cover some of the advantages, disadvantages and opportunities in relation to Capped Income Drawdown.

In the meantime, should you have any queries, feel free to contact us.