Pension (or income) drawdown is one of the ways you can use your pension pot to provide a regular income when you reach retirement. Drawdown is a flexible way of accessing your pension, while allowing your pension fund to keep growing. Here, we explain exactly how drawdown works and whether it’s right for you.
Pension drawdown is available to those aged 55 or over (increasing to age 57 in 2028) and enables you to take an income from your pension pot while leaving your remaining pension savings invested.
You can choose to move your pension into drawdown in one go or a little at a time. You may be able to do this with your current provider or by transferring your pension to a drawdown provider elsewhere. If you decide to transfer, it’s important to first check you won’t lose any valuable benefits or be charged high exit fees.
Under rules introduced in April 2015, you can take up to 25% of your pension pot you use for drawdown as tax-free cash – you can take this in one go or each time you move part of your pension into drawdown. Further withdrawals can then be made as and when you choose, whether you do this in one go, take regular monthly payments, or withdraw lump sum payments as and when you need them.
- Drawdown allowances and tax rules
- What are the benefits of drawdown?
- What are the downsides?
- How to manage drawdown funds during retirement
- Key questions to consider
- How we can help
The first 25% you take of your pension pot will be tax-free, while the remaining 75% will be subject to Income Tax. How much you pay will depend on your total income for the year and your tax rate. For 2020/21 this means:
- if you have no other income, no tax will be due on the first £12,500
- on income between £12,501 and £50,000 you’ll pay tax at 20%
- on income between £50,0001 and £150,000 you’ll pay tax at 40%
- on income over £150,000, you will pay tax at 45%.
One of the biggest advantages to drawdown is the flexibility it offers. Not only does it enable you to take money from your pension savings whenever you need it, there’s no limit on the number of withdrawals you can make, and you can take out different sums each year.
At the same time, the remainder of your pension pot can stay invested which means if your investments perform well, your income could grow throughout retirement. Drawdown gives you the option of being able to choose your own investments, use ready-made portfolios or let an adviser choose on your behalf.
It’s important to understand that it’s your responsibility to ensure your retirement income lasts the duration of your retirement and to understand that the more you withdraw from your pension pot, the quicker it will be depleted. If you make withdrawals too frequently, your retirement income could run out earlier than expected.
Consider, too, that large withdrawals can push you into a higher tax band and, as soon as you withdraw more than your 25% tax-free lump sum, the Money Purchase Annual Allowance (MPAA) applies which limits the amount that be contributed to your pension to £4,000 per year.
Additionally, there’s no guarantee that your investments will continue to grow which means you could get back less than you invest.
Buying an annuity is still appropriate for many people in retirement as it allows you to use your pension savings to buy a guaranteed income that lasts the rest of your life. If you prefer, you can use part of your pension savings to buy an annuity and leave the remainder in drawdown.
If you’re considering drawdown, it’s important to plan carefully, taking into account how long you need your pension to last – remember that your retirement could last 30 years or more. As part of this, you’ll need to consider what to do with any cash you withdraw over the short, medium and long-term:
Short-term: when still in employment, it’s advisable to keep three to six months’ worth of income in a current account or savings account that will give you instant access for covering emergency costs. Upon retirement, this should increase to one to three years’ worth of expenditure.
Medium-term: cash that’s not required in the immediate future could be tied up in a fixed term savings account as these tend to pay higher interest rates than you’ll get with an easy access account. In return, you must leave your funds untouched for the term of the account, which could be anywhere between six months and five years. As a general rule, the longer the term of the account, the higher the rate of interest. You could choose to lock some cash away in a shorter-term account, and another chunk in a longer-term one.
Long-term: investing can be a good option for any cash you won’t need to use for longer than five years. Investing in the stock market tends to give better returns than cash savings over the long-term but remember that your investments can fall in value as well as rise, so you should ensure you understand the risks involved first.
Before deciding whether pension drawdown is right for you, it’s worth asking yourself the following questions to ensure you fully understand your options:
- How much of my pension do I want to move into drawdown?
- Will I be charged an exit fee if I transfer my pension?
- Am I comfortable managing my retirement income or would a guaranteed income be more suitable?
- How regularly should I make withdrawals?
- Am I comfortable with the investment risk and do I have other income to fall back on?
Should you need help answering these questions, our expert pension advisers are on hand to discuss all your pension and retirement options. We take a holistic approach tailored to you, the individual, and will always make alternative suggestions if appropriate.
Our advisers will talk to you in jargon free language to help you understand your choices and our advice and recommendations will be focused on helping you to get the best possible result.
The value of investments can go down as well as up and you may not get back the full amount you invested. The past is not a guide to future performance and past performance may not necessarily be repeated.
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This material is intended to be for information purposes only and is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Past performance is not a reliable indicator of future returns and all investments involve risks including the risk of possible loss of capital. Some information quoted was obtained from external sources we consider to be reliable.
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Chat to the Author, James Appleby
Managing Director, Wealth Management, Bishop's Stortford officeMeet James