Over half (59 per cent) of people in income drawdown are not actually taking any income, Skandia exclusively revealed to Pensions Age after a study among its pension customers.

The pensions and life assurance company said that the decision to go into drawdown is often driven by the desire for the tax-free cash lump sum, but that problems can arise further down the line, if the remaining pension fund is ignored.

After the changes that came into effect in April 2011, the tax charge on death for income drawdown funds has increased from 35 per cent to 55 per cent, for those dying before age 75. This also applies to those who do not take an income, but only take their tax free cash.

Individuals who are taking the tax free lump sum but decide not to draw an income will therefore need to decide how to use the remaining capital in their pension drawdown fund to improve tax efficiency, Skandia said.

If an income is not needed, the most favourable option might be to reinvest all, or part of it, back into a pension as a new contribution. Until age 75, contributions up to £3,600 a year can be made and although the income in retirement will be taxed at their highest personal rate, they will receive income tax relief on any contributions paid back into a pension at the same rate of tax, thereby avoiding any effective cost.

This way, these pension contributions and any future growth on them will be exempt from the 55 per cent tax charge on death, provided they are within the lifetime allowance and they die before their 75th birthday.

For those using flexible drawdown, any contributions paid in the tax years following the commencement of flexible drawdown will not receive any tax relief. An alternative for them would be to reinvest in other savings vehicles such as ISAs.

Due to the rule change in April 2010, which saw the pension age increase from 50 to 55, more people are in drawdown but are not taking an income. Those aged between 50 and 55, who did not want access to their tax free cash delayed, opted to go into drawdown earlier than planned. Although this gave them the tax free cash, it left them in drawdown with no immediate need for the income, especially as many were still in employment.

Skandia’s pension expert Adrian Walker said: “The number of people currently in drawdown and not taking an income highlights just how many individuals could benefit from further financial planning to achieve better long-term outcomes both for themselves and their beneficiaries. We believe that our statistics would be mirrored to a large extent across the industry.

“The increase to the pension age, introduced in April 2010, undoubtedly had an effect on these numbers, with customers taking their tax free cash sooner rather than later. The latest economic uncertainty could also be having an effect, where customers are uncertain as to what to do next with their pension fund given the downward push on gilt yields that are impacting the current annuity level and income withdrawal that can be secured.

“The increase to the rate of tax applicable on death for people in drawdown only came into force from the start of this tax year and many people will not be aware of the change. Something so simple, such as taking the income and reinvesting it as a new pension contribution, can, over time, have a significant impact, especially if the person continues working for a number of years and the current economic climate improves.”

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