Pension Drawdown allows you to control your access to your pension funds. As long as you’re confident managing your money, you can use this to create a flexible retirement income.
What is pension drawdown?
Pension drawdown lets you take money as and when you want from your Defined Contribution pension. You can begin pension income drawdown at age 55 (although this is rising to 57 from April 2028) if you wish. But remember, the decisions you make will affect the income you receive for the rest of your life – which is why many choose to talk to a financial adviser before making any decisions.
How does a pension drawdown work?
You may not know that your Defined Contribution pension savings are subject to tax. As you received tax relief when building your pension pot, only 25% of your pension is tax-free and the rest is subject to tax at your marginal rate. With pension drawdown you can either:
- Immediately take 25% tax free, investing the rest, and each subsequent withdrawal is subject to tax.
- Spread across multiple withdrawals, with up to 25% of the value of your pension tax-free.
There are benefits to each option. Whether or not you decide pension income drawdown is right for you depends on your financial situation. Taking a larger lump sum at the beginning of retirement could help you pay off your mortgage or other debts, or make adjustments to your home. But leaving more of your funds invested could give them the opportunity to grow. Whichever option you choose, pension drawdown carries the risk that you will run out of money drawing down your pension.
- Check your current pension terms
Your current pension provider may not offer a drawdown arrangement, so in this case you would need to transfer away. It’s important to check if there are any valuable features of your current plan that you’d lose, or if there would be any charges to pay, so speak to an independent financial adviser.
If you’re still working and you or your employer are contributing to a Workplace pension, withdrawing funds other than the tax free element will trigger the Money Purchase Annual Allowance (explained below) and affect how much you can contribute tax efficiently.
- Decide where to invest the rest
Once you’ve decided that pension drawdown is for you, you’ll need to choose how you want to invest the rest of your drawdown pension pot. Investing gives your funds a chance to grow over time – but they could perform poorly.
How you invest is important, as assets will need to deliver steady growth to combat the effects of any withdrawals. A financial adviser can help you when considering pension freedoms, recommending suitable investments, and designing a plan based on your current and future spending plans.
- Watch out for an unexpected tax
Tax in the UK is complex. There are a few thresholds it’s wise to look out for when you’ve started to withdraw funds from your pension:
- Personal allowance – Your pension is considered to be income, just like a salary. You can receive up to £12,570 (for tax year 2024/25) and not pay any income tax. (Your personal allowance might be higher if you qualify for Marriage Allowance which allows you to transfer some of your Personal Allowance between partners.) How much tax you need to pay depends on your income tax thresholds.
- Annual allowances – Before you take money flexibly from your money purchase pension, you can save up to £60,000 tax-free, each tax year (although personal tax-relievable contributions are limited to 100% of your earnings or £3,600 if more). But once you’re making flexible withdrawals from your money purchase pension, this changes to the Money Purchase Annual allowance for money purchase pension funding, and further money purchase pension contributions over £10,000 will be subject to tax. This is designed to prevent double tax relief. If you’re not sure why you would want to continue to contribute to your pension in retirement our article explains.
- Lifetime allowance – This is a limit to the amount you can build up over your lifetime without suffering an additional tax charge. The lifetime allowance for the 2023/2024 tax year is £1,073,100 but the lifetime allowance tax change has been removed. The lifetime allowance is to be abolished in 2024/25 and by new allowances relating to tax free lump sums only. From 2024/25, the maximum you can withdraw from your pension tax-free during your lifetime will be capped at £268,275 for those without lifetime allowance protection.
- Plan your withdrawals
Before taking any money from your pension, consider how your withdrawals (and future withdrawal plans) will impact your pension and its performance.
The general consensus is ‘Don’t take more than you need to.’ Pensions freedom will let you vary the amount you take each year, and whether or not you wish to make multiple withdrawals.
- Continue to review your pension fund
It’s important to remember that your pension pot is a limited size. As you withdraw funds, you will have less money to benefit from investment performance. During years of poor performance, your fund can shrink much faster than expected and may affect your future withdrawal decisions, so it’s important to keep an eye on your pension fund. Unlike an annuity (which we will discuss shortly), a drawdown scheme can run out of money.
Is a pension drawdown suitable for me?
There are several features we’ve hinted at so far which may make Pensions Freedom an attractive option for your retirement income.
Consider your other benefits
Before withdrawing any funds check that your retirement income will not interfere with your eligibility for other benefits. Your State Pension or Means Tested Benefits may be affected.
Flexible, but not guaranteed
Accessing your Defined Contribution pension through pensions freedom rules can give you access to more cash, but your future income won’t be guaranteed. The more money you take, the faster your pension will be depleted and the more likely it is to run out.
You can vary your income
You can increase and decrease the amount of money you take, stop and start withdrawals at any time. If you’re aware of big life events, you may decide you need to access your funds for a one-off expense, such as for a wedding or house move. Pensions drawdown isn’t the only option for you in this case.
Passing on your legacy
With pensions drawdown you can leave what’s left in your pension plan to your loved ones when you die, generally free from inheritance tax. Normally death benefits are free from income tax on death before the age of 75, within allowable limits. On death after 75 your beneficiaries will need to pay income tax at their marginal rate on amounts they withdraw.
Changing your mind
You can convert your pension income drawdown funds to an Annuity at any point and benefit from a guaranteed income. But bear in mind that how much an annuity will provide depends on how much you have to invest, as well as your age and other factors.
What will happen when your pension fund runs out?
Decisions you make about your retirement will affect your future quality of life. Withdrawals from your pension drawdown fund are irreversible. You should consider your other assets and sources of income before going ahead with Pension drawdown and engage a financial planner, who can do a “cashflow forecast” for you, which can help illustrate how your withdrawals might work.
What are the alternatives to a pension drawdown?
Pension drawdown might be gaining in popularity, but it’s not your only option:
- Leave your pot invested – Just because you turn 55 doesn’t mean you have to use your pension fund. You can leave it invested.
- Annuity – Deciding whether you should choose an annuity vs drawdown is regularly debated in news columns. At any point you can use your pension pot to buy an annuity – even if you’ve begun flexi-access drawdown. This provides you with a regular income (although how much you’ll get will depend on a number of factors such as provider, your age, how much you have to invest, etc.) One of the main benefits of an annuity is that it takes care of itself once it’s set up, and with a lifetime annuity you’re guaranteed this income for the rest of your life, so there’s no danger of it running out.
- Withdraw in several ‘chunks’ – You can withdraw larger amounts from your pension pot until it runs out. Similar to Pension income drawdown, this is known as UFPLS ‘Uncrystallised Funds Pension Lump Sum’. You can find out more about this in our Retirement Tax planning guide.
- Withdraw your entire pot – You can take your entire fund in one go – but depending on how much you have saved, remember that any earnings above your personal allowance will be subject to income tax.
- Mix your options – You can defer taking an income, take just what you need, or even take part of your fund and buy an annuity. If you have more than one pension, you can also choose different options for each one. The more complex your retirement planning, the more we’d recommend that you talk to a financial adviser.