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Income Drawdown And Phased Retirement

September 24, 2003

In this article we look at two methods that can be used to make your pension a little bit more flexible.

 Income Drawdown

One way that the current system of drawing on your pension does provide some flexibility is through a process called 'income drawdown', or 'income withdrawal'. By taking income drawdown when you retire, you can delay the purchase of your annuity until you're 75. In the meantime, you draw an income directly from your pension fund. This income must be at least 35% and not more than 100% of what you would have got if you had taken an annuity. The precise limits are calculated by the Government Actuaries Department.

The main advantage of income drawdown is that you're able to take the income you require (subject to the limits) while ensuring your fund stays invested in assets with more potential for growth, like shares. This introduces some risk, because the shares might go down while you're waiting to get the annuity. However, most usually if they do, then it'll be because long-term interest rates have gone up. In which case, the rate you get on your annuity will also have gone up even though you now have less to buy one with. The basic point is that the income that you can get from a pile of assets is generally much more stable than the price of those assets. That should provide some protection against stock market movements. However, you do a fairly large pension pot to make this whole process cost effective.

If you die while you are using the income drawdown method, then some or all of your pension fund can be passed on to a nominated beneficiary such as a spouse. There are two options. In the case of a spouse or dependant, the whole fund can be used to provide an income, by buying an annuity or under income withdrawal. Alternatively, the spouse, dependant or beneficiary gets the full cash value of the fund minus 35% which goes to the Government (it's a way of them getting their tax relief back).

Phased Retirement

One other thing worth mentioning, while we're on this fiddly stuff, is 'phased retirement'. This is not to be confused with income drawdown, although the effects aren't entirely dissimilar. If you have a money-purchase scheme that allows for "segmentation", then it means that the scheme is, in fact, lots of little schemes rolled into one. Each small bit of the scheme is its own discrete pension, and you can take the benefits from each of them when you like, between the ages of 50 and 65. So you could, perhaps, take one bit of your pension every month from the age of 55 to 60. That way you gradually phase in your retirement benefits.

Phased retirement can be used in conjunction with income drawdown and is particularly useful for the self-employed or, indeed, anyone who wishes to wind down their workload (and income) gradually over several years. As ever, though, watch out for the costs associated with taking this type of option.

Find out more in the Fool's pension centre.