Pension drawdown – What you need to know

Pension drawdown – What you need to know

Have you heard of pension drawdown but aren’t sure exactly what it is? I’m Charlene Young at AJ Bell and in this short video I’m going to explain how pension drawdown works. We’ve discussed the main options you’ve got to access your pension in another video, including the age you can start, so please also give that a watch. So drawdown – or to give it it’s official name, 'flexi-access drawdown’ allows you to keep your pension pot invested while taking an income out as and when you need it. It’s flexible, it puts you in control — but there some important things you need to know. 

As we discussed in our options video – if you choose to take a tax-free lump sum, you need to choose an income option for the remainder of your pension pot. With drawdown you can take regular monthly payments, ad hoc payments of income, or even choose to take nothing at all from the pot for the time being. The main thing to remember is that drawdown income is subject to income tax, just like money we earn as salary in our working lives. What you move into drawdown can stay invested. This gives your money the chance to continue to grow — but as we know, investments can go down as well as up, especially in the short term. There are four main advantages of drawdown. 

First, you’re in charge. We’ve talked about income flexibility – there are no limits so you can take as little or as much as you like. This gives you the flexibility to cater your income to your needs. Second, the funds stay invested in the pension wrapper – where hopefully they can grow over time and keep pace with or even beat inflation. And they will continue to be protected from tax. 

Third, it’s not a final decision. If you go into drawdown to start with, you can change this and buy an annuity later – perhaps once you are older if that’s a better fit for your circumstances. And finally, anything left in your drawdown pot can be passed onto your beneficiaries when you die. There are a few risks of drawdown that you should consider. First, the income is not guaranteed. If you want a secure, guaranteed income from all or part of your fund, you should consider buying an annuity from an insurance company. 

Second, you could run out of money if your pension is depleted at a faster rate than you had planned. This might happen if you take a high level of income, live for longer than expected,  sell investments to fund your withdrawals when investment markets have fallen or see large drops in the value of your investments. And finally, you’ll need to be happy to manage your pension investments yourself, which will take time and effort. You’ll need to pay a fee if you decide to appoint a financial adviser to do this for you. After any tax-free lump sum, you’ll need to pay tax on pensions withdrawals.

Drawdown withdrawals are taxed as income. This could you push you into a higher tax bracket for the year, particularly if you are still working or have income from other sources, like the State Pension or another pension. Planning withdrawals carefully can make a big difference to the amount you receive after tax. Taking a drawdown income payment for the first time will also trigger the money purchase annual allowance.

This is a reduced allowance of what you can pay into certain types of pension each year, of £10,000 a year, and covers the total amounts from you and your employer if you’re still working. This might not be an issue for you if you have fully retired and do not intend to top up you pensions in the future. Whether or not drawdown is the best choice for you will depend on your personal circumstances and your income needs in retirement. 

Many people really value the flexibility that drawdown brings, especially if they are comfortable with still managing their pension investments. But others want the peace of mind of a secure income. We’ve got lots of information on our website on drawdown, including ideas on how to manage your investments in the run up to and through retirement. But we cannot give your personalised advice – if you want to know which option is the best for your retirement goals, please speak to a regulated financial adviser.