A:

While there are similar drawdown plans in the United States, a pension income drawdown plan most commonly refers to a specific pension withdrawal system used in the United Kingdom that is governed under the Financial Conduct Authority. The income drawdown plan provides a means for retirees to access pension income while allowing part of their pension funds to continue growing from returns on investment. Pension income drawdown allows retirees the potential for more substantial retirement income, depending on how well their pension fund investments perform.

Pension income drawdown was developed as a more flexible alternative to the traditional practice of taking entire pension funds upon retirement and investing them in annuities. It applies to all U.K. citizens with defined contribution pension plans. Defined contribution pensions are established over time through regular contributions to a pension fund by either an employee, an employer or both. The money contributed to the pension fund is invested so that the amount of money in the fund is ideally increasing through investment returns.

Of course, investing always carries some level of risk, so it is possible for the fund to suffer losses as a result of investments. Because of this possibility, most pension plan holders opt for fund investment plans with very conservative investment strategies, although they do have the choice of investing in higher-risk strategies that offer correspondingly higher potential investment returns.

The total amount of money available at retirement depends on how much has been contributed to the pension fund and the performance level of fund investments.

There are two options for pension income drawdown. The first type of income drawdown plan is capped, which means that only a certain amount may be withdrawn from the pension fund on an annual basis. The amount available for withdrawal is determined by the U.K. Government Actuary Department (GAD) and is calculated in relation to the annuity amount that would be available to a person dependent on age. 2014 changes in the pension income drawdown plan increased the annual withdrawal limit to 150% of the amount determined by the GAD. Previously, the annual withdrawal limit was 120% of the GAD-determined amount.

The second pension income drawdown plan option is flexible drawdown. Under the flexible income drawdown plan, there is no limit to the amount that a person may withdraw from a pension fund at any time. To qualify for the flexible drawdown plan, a person has to have a guaranteed before-tax annual income of £12,000. This is a reduction under the new 2014 rules from the previously required pre-tax guaranteed income level of £20,000. While there is no limit on pension fund withdrawals, there are tax considerations. Twenty-five% of annual withdrawals are tax-free, but the other 75% of annual withdrawals are taxed as income.

With either pension income drawdown plan option, remaining pension funds not withdrawn continue to be invested. It is critical for retirees to plan and manage their withdrawals and pension fund investments so that the pension funds adequately provide for their needs and are not exhausted prematurely. Many retirees opt for professional portfolio management.

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