Pensions: income drawdown

Individuals with defined contribution (money purchase) pensions build up a pension fund using contributions, investment returns (if any) and tax relief. At present, most people (75%) with a DC pension use it to buy an annuity at retirement. The advantage is that an annuity provides a guaranteed income for life and the individual no longer bears any investment risk. Under current rules, the main exceptions to buying an annuity are that: some people with small amounts of pension saving or very small individual pots may have the option from age 60 to take all of it in the form of a lump sum. There is also the option of “income drawdown”, which allows the individual to draw an income from their fund while leaving the rest of it invested.

The Labour Government’s policy was to require people to turn their pension fund into an income stream by the age of 75 (sometimes known as the “requirement to annuitise”). This was on the basis that generous tax incentives to encourage people to save for an income in retirement made it reasonable to require people to turn their pension fund into an income stream by age 75. However, it introduced the option of an Alternatively Secured Pension from age 75, aimed at people with religious objection to the pooling of mortality risk.

The current Government legislated to end the “requirement to annuitise” at 75. Accordingly, sinceApril 2011, income drawdown has been an option throughout retirement. However, except for people with other pension income over a set amount, the amount that can be withdrawn each year is capped.

In Budget 2014, the Government announced reforms to take effect from 27 March 2014, including more flexibility for income drawdown arrangements. This was in advance of more radical proposals to allow people from April 2015, whatever the size of their defined contribution pension pot, to take it from age 55 “how they want, subject to their marginal rate of income tax in that year” – see HM Treasury, ‘Freedom and choice in pensions’. These longer term changes are discussed in a separate note SN 6891 Budget 2014 – flexibility for DC pension savers from April 2015.