Since so-called ‘pension freedoms’ were announced in 2015, retirement planning has become more flexible, but also increasingly complicated. And because a fixed retirement date and guaranteed pension are no longer typical, and people are living healthier, longer lives, more people are exploring options that give them flexibility in how they take their retirement income.

Pension Drawdown is one such option. Though it has existed for many years, it’s really taken off in popularity since the arrival of pension freedoms.

Many investors find that the variable nature of a drawdown contract suits their retirement plans

What is Pension Drawdown?

In simple terms, pension drawdown allows you to treat your pension like any other investment. It allows you to:

  • Keep your pension invested after you retire
  • Take 25% of your pension fund tax-free, either in the form of income or as one, or more, lump sums
  • Select the level of income you require, which will be taxable (apart from the 25% tax-free element)
  • Take your income monthly, quarterly, annually, or when needed
  • Withdraw your entire pension pot as a single lump sum (although this is usually not advisable as the tax bill for doing so will be significant)
  • Pass any remaining pension pot onto your loved ones when you pass away

What is Capped Drawdown?

If you started taking benefits from your pension before 6 April 2015, your fund may still be in ‘Capped Drawdown’. This means there are limits on the amount you can withdraw.

It’s usually simple enough to transfer this into a Flexible Drawdown contract to remove the restrictions. However, this will trigger the Money Purchase Annual Allowance (MPAA), which limits future pension contributions to £4,000 per year. The best option for you will depend on your circumstances.

What are the benefits of Pension Drawdown?

Many investors value flexibility over guarantees and find that the variable nature of a drawdown contract suits their retirement plans. Drawdown has the following advantages:

  • Your investment can still grow after you retire
  • Your retirement income can be varied. For example:
    • You could take a small amount of income in the earlier years as you transition into full retirement
    • This can be increased when you stop work, or adjusted when you begin to receive income from other sources (like the State Pension)
    • You might find that you spend less as you get older, so need less income for a period
    • Care costs could apply later in life, requiring your income to increase again
  • Because drawdown pensions can be passed on when you die, they can be a useful estate planning tool

Because the fund remains invested, it can fluctuate and even lose money

What are the disadvantages of Pension Drawdown?

Of course, there are some risks and possible disadvantages to pension drawdown too.

  • Because the fund remains invested, it can fluctuate and even lose money
  • It will be harder for your fund to recover from any losses, since the income you take from it will reduce its overall value
  • You might run out of money if your withdrawals exceed the fund’s growth
  • Taking income from a drawdown plan triggers the Money Purchase Annual Allowance (MPAA). This reduces your annual allowance (the amount you can pay into your pension while receiving tax relief) to just £4,000
  • If you take your income on an ad hoc basis, emergency tax may be applied rather than your standard income tax rate. This can be reclaimed, but it takes time
  • Administration of the plan can be complex and requires regular reviews, which may incur additional costs to you
  • Your fund will be tested against the Lifetime Allowance (the total amount you can invest in a pension while still enjoying the tax benefits), not only when you first take benefits, but again at age 75. This means fund values over £1,073,100 (as at 2022/23) will face significant tax charges.
  • Not all contracts offer drawdown, meaning you may need to transfer your pension to a new plan.

Drawdown should be considered as part of a comprehensive retirement plan that reflects your unique needs and circumstances. Given the complexities and potential pitfalls, it’s important to seek advice from a financial planner before making any decisions.

Annuities provide certainty, but any options you want to include must be chosen at the outset

What are the alternatives to Pension Drawdown?

Drawdown is not your only option for taking income from your pension when you retire. Assuming you have a defined contribution pension, where the size of your pension is determined by the amount you invested and the pension fund’s performance (like most workplace pension schemes today), you’ll have several other choices.

Annuities

You can use your pension fund (after you have taken your tax-free lump sum) to buy an annuity. An annuity is a contract which will pay you a guaranteed income for life.

Your annuity rate (the amount you receive each year) will depend on your age, health, and lifestyle, as well as any other additional options you might select as part of the contract. For example, you may want to have your annuity payments passed to your spouse when you die.

Annuities provide certainty, but any options you want to include must be chosen at the outset. There is no scope to change your mind or add features as your requirements change (for example, you won’t be able to remove a spouse’s pension from the contract if your partner dies before you)

Uncrystallised Pension Fund Lump Sum

Most people are aware that they can withdraw their full pension fund as a lump sum – although this will usually incur a significant tax bill. But it’s also possible to withdraw it in phases.

For example, if you have a £100,000 pension pot, you could take a lump sum of £10,000 per year for ten years. The first 25% of this would be tax free, with the remainder taxed as income.

Other options

Many pension providers who do not offer drawdown will still allow you to take partial lump sum withdrawals.

‘Guaranteed drawdown’ or ‘hybrid’ plans – which have the growth potential of drawdown combined with the guaranteed lifetime income of an annuity – are another option. But as they typically provide a lower maximum income than both of those choices, they tend to be less popular.

Is drawdown right for you?

Whilst pension drawdown keeps your pension invested and enables you to take a variable income, your money will still be exposed to risk, and will rise and fall in-line with the financial markets.

Before you decide on the best course of action it’s important to seek professional advice. Amber River financial planners will be able to explain all the options open to with a projected income for each, accompanied by their recommendations based on your personal circumstances.

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To speak to one of our team, arrange an appointment or find out more, call 0800 915 0000, or alternatively use our contact form here.