Pension drawdown is a highly flexible way of taking your pension. Also known as income drawdown, it used to be open to only those with larger pension pots, but it’s now an option for most people with a defined contribution pension.
If you’re new to pension drawdown (from April 2015 onwards) you’ll enter into an arrangement now known as flexi-access drawdown, so called because of the far greater level of flexibility it provides for taking your pension.
You can only access your pension pot through income drawdown once you hit the age of 55 in the vast majority of cases. This is the same as the rules for accessing your pension in all other ways, unless you’re part of a scheme that grants you early access or you’ve been diagnosed as severely / terminally ill with a considerably shortened life expectancy.
When you designate all or part of your pension to income drawdown you’re entering into a flexible pension arrangement.
Rather than handing over your pension pot to an insurance company in exchange for an income for life known as an annuity, pension drawdown leaves you free to leave your retirement savings invested and create your own programme of lump sum and income payments.
You can take the first 25% of your pension as a tax-free cash lump sum before you move your pension into income drawdown.
Assuming you do choose to take the 25% tax-free cash lump sum from your pension, drawdown offers you two retirement income options:
If you don’t take the 25% tax-free cash lump sum you’re entitled to at the outset, you may be able to receive 25% of any lump sums or income payments you receive from the drawdown fund tax-free at a later date.
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For high earners it is important to note you’re capped in terms of how much you can receive as a 25% tax-free lump sum by the pension lifetime allowance.
If your pot is worth more than the current £1,073,100 lifetime allowance (this ceiling may be higher if you’ve protected your lifetime allowance), your tax-free cash lump sum will be capped at 25% of your lifetime allowance, regardless of the size of your pension pot.
There is a third way of drawing down your pension — this involves taking an uncrystallised fund pension lump sum (UFPLS) out of your pension pot. This is also known as a FLUMP.
However, it’s slightly different from pension drawdown in that it’s only available on any uncrystallised pension funds, i.e. those that aren’t in drawdown. Instead, you leave your pension cash where it is (invested with your pension provider) and take lump sums direct from the pot as required.
Every time you withdraw cash from your pension with an UFPLS, the first 25% of each withdrawal is tax-free.
For uncrystallised pension funds you choose to access through drawdown, there’s no initial upfront 25% tax-free payment. Every 25% tax-free lump sum has to come with an accompanying 75% of taxable cash. So if you want £10,000 tax-free using a UFPLS, you’d also have to take £30,000 of taxable cash.
UFPLS is slightly less complicated than pension drawdown because you don’t have to find a drawdown provider and pick investments for that fund. However, not every pension provider will allow you to take UFPLS and some may charge each time you take a lump sum.
Also, as you move closer to retirement your pension provider tends to put your cash into safer investments to lower the risk of loss that you won’t have time to regain. That could mean that cash that stays invested in your pension pot may only have limited growth potential.
You’ll have to carefully consider where your pension pot is invested if you’re considering using UFPLS and whether it will provide the level of growth necessary to sustain your withdrawals in the long-term.
As with other areas of pension drawdown, it’s best to discuss your options with an adviser before choosing a series of FLUMPs to provide your retirement income.
There’s no rule regarding how much of your pension can be designated to drawdown. You can designate as much or as little as you like, when you like.
You don’t have to put your pension into drawdown all at once — you can use phased income drawdown to shift your pension into drawdown gradually. Every time you take money out of your pension pot and put it into a drawdown fund, the first 25% of your withdrawal is tax-free.
Keep in mind that some pension providers could charge each time you designate cash to drawdown. Working with a qualified pensions adviser they should shop around to find the best income drawdown option for you. This may mean moving your pension pot from one provider to another before entering into drawdown.
In many cases, especially for those with multiple pension pots and other steady income streams in retirement (e.g. buy-to-let properties or a separate final salary pension), income drawdown can be a more tax-efficient way of taking your pension. This is because pension drawdown gives you an adjustable pension income that you can alter as necessary in any given tax year to keep yourself out of higher tax bands.
When comparing an annuity with flexi-access drawdown, the one thing you won’t get with pension drawdown is security. An annuity will pay you a guaranteed income for the rest of your life — and may even pay a reduce survivor’s pension to your spouse or civil partner after your death as well.
Even if you live for long enough that your annuity payments start to exceed the amount you had in your pension pot when you bought the annuity contract, the insurance company has to continue paying you.
Did you know…?
According to the Office for National Statistics, 1 in 10 men aged 50 today is expected to live to 100.
If you opt for pension drawdown, the pot is finite. So if you take too much cash, or your investments don’t perform as you hoped, then you risk running out of money further down the line.
Our Pension Drawdown Calculator below can help determine when your pension pot will run out depending on its investment performance, how much income you’re expecting to draw from it per month and factoring in your age and life expectancy.
The calculator can also work out how much you should set your pension income at to make it last to a specific age, again based on investment performance.
There’s no easy answer as to whether pension drawdown is the best retirement option for you.
It depends on a number of factors, such as your age, state of health and life expectancy.
The size of your pension investments is also crucial — those with smaller pension pots may not be able to make their pension last for as long as they require and an annuity could therefore be a better option.
If you’re looking for a guaranteed income for the rest of your life and aren’t overly keen on taking on investment risk in your later years, then it’s likely that you’ll find an annuity is better than income drawdown.
However, if you’re looking for a more flexible and tax-efficient way to take your pension with more control over your retirement savings, then it may well be that pension drawdown is better than an annuity in these circumstances.
Once you’ve started using pension drawdown, if you decide you want a guaranteed, stable income as you get older you can always purchase an annuity with the remainder of your pension pot at a later date. However, if you buy an annuity first with your entire pension pot you can’t then change your mind and opt for pension drawdown.
Also, remember that your current pension provider may not currently allow you to use income drawdown. If that’s the case, you’ll have to transfer your pension to another provider who will.
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