If you’re over the age of 55 in need of an urgent cash injection, you may be able to turn to an unexpected source – your pension fund. Provided it’s built up to a suitable level, you can release a tax-free lump sum without either having to retire or drawing an income from your pension fund. This sum can be used for any purpose you chose, including clearing personal debts, and it’s known as a “drawdown pension.” You may also take regular income withdrawals, although unlike the lump sum, these are taxable. But what are the advantages and disadvantages of making use of drawdown pensions like this as a source of windfall or regular income?
The option became available in 1995, since when 180,000 people have invested in drawdown schemes. But it’s as well to keep a canny eye on the stock market before you proceed with a withdrawal. Income drawdown allows you to take an income from your pension while leaving what remains invested in the stock market. And as we’ve seen in recent years, there have been some unprecedented corrections afflicting the stock market which could seriously erode pension capital if drawdowns take place during another severe correction. Some pension analysts have issued warnings in the light of this turbulence, predicting that if people take income from their drawdown pension in a plunging market, savings can be whittled away at an alarming rate.
One way of protecting your savings is to make sure that your withdrawals remain within the natural yields of any investments you may have (i.e., any dividends paid on equities, or interest on cash you’ve invested, or any income you make from property rental). This way, your capital will remain safe.
Less risky options include ensuring that your fund is invested wholly in cash, spread across several financial institutions. If it is, it’ll be relatively safe. However, if the fund is invested in a mixture of cash, equities and corporate bonds, you’re best advised to draw income only from the cash element. The riskier elements need a chance to recover from the recent turbulence. But – and it’s an important but – they tend to produce much more exciting growth when times are good than cash-only investments.