One of the options that you may be considering when you are planning your pension is an income or pension drawdown. A pension drawdown is an alternative to an annuity which allows you to draw an income from a pension fund that you have invested without having to buy an annuity when you retire.
The big difference and potential advantage of an income drawdown over an annuity is that a pension drawdown allows you to benefit from positive market conditions. In other words, you are investing your money at the same time and your investment has the potential to grow. With an annuity, you pay a lump sum to an insurance company and then get set payments in return. This income drawdown allows you to take income from your pension savings while getting the benefits of an invested sum. Because the benefit of getting a cash lump sum upfront a pension drawdown is becoming an increasingly popular option, but there are also pitfalls to consider. Chiefly, an income drawdown suffers the same risks as any investment income.
One of the big downsides of taking a drawdown is that a market downturn can cause your pension capital to be eroded. A market downturn for someone who is already drawing income from their pension savings can cause a rapid decline in the pension.
Ideally, you would want to keep your pension withrawals close to the natural yields on your investments so that they don’t erode your savings too quickly. Remember that your are only drawing down your pension early. So if you are too aggressive with your dispursements, you could seriously erode your retirement pension. This problem can be seriously compounded when there is a market downturn.
Of course there are upsides to taking a pension drawdown. The chief benefit being able to draw your retirement income early.
There are different types of income drawdown split generally into two parts: A flexible drawdown and a capped drawdown. Each type of income drawdown has it’s own pros and cons.
A capped drawdown is a type of income drawdown where the payments are capped or limited to a certain amount. This maximum amount is a percentage of the amount of the annuity that you could have bought. These limits are calculated by the Government. This maximum rate is reviewed and recalculated regularly.
With a flexible drawdown, you are able to drawdown a more flexible amount of funds without maximum income limits so long as you meed certain conditions. Generally if you meet the Minimum Income Requirement and age 55 or older, you may be able to do a flexible drawdown.