What is Pension Drawdown?

When we approach retirement age, deciding how to access our pension can be confusing. This article will attempt to break down some of the facts surrounding pension drawdown.

Pension drawdown is a method of withdrawing funds from your pension to supplement your income during retirement. To access your money in this way, you must be 55 years or older.

What are the pension drawdown rules?

The main rule is you can access your pension from age 55 and you have 25% tax-free with the remaining 75% taxed at the marginal rate of income tax. However, there are certain situations when you may be able to access your pension early due to medical retirement or terminal illness.

However, before you access your personal or workplace pension, it’s a good idea to speak to an independent financial adviser to talk through your options and offer pension advice before making any decisions that could impact your retirement income.

It might be tempting to tap into your pension as a source of ready tax-free cash. But remember that the primary purpose of your pension is to provide income for a comfortable retirement. Drawing down money too soon could impact your future finances and retirement lifestyle.

Pension drawdown is an option for people with a defined contribution pension. You might know these as SIPPs (Self Invested Personal Pensions), personal pensions, workplace pensions, stakeholder pensions or ‘money purchase’ schemes.

A defined contribution pension means you pay in an agreed (defined) amount throughout your career.

When the time comes to access your defined contribution pension, you can withdraw up to 25% as a tax-free lump sum (often called a pension commencement lump sum) but you must do something else with the remaining 75%. This post explains how you can trasnfer your defined contribution pension.

There are two options for this: drawdown or annuity.

At Joslin Rhodes, we call these the ‘box’ and ‘barrel’.

• Annuity – One option is to use your pension pot to buy an annuity. An annuity pension is a product that pays out a regular monthly income for the rest of your life or agreed term. We call this a ‘box’ because it is like a little box of cash pumping out pound notes every month.

• Drawdown – Another option is to invest your pension pot and drawdown money as and when you need it. We call this a ‘barrel’. Imagine a barrel with a tap that you can turn on or off, depending on how much money you need to access at any one time.

You don’t have to choose one or the other. It’s possible to combine a box and a barrel approach. For example, splitting your pension pot equally between the two, giving you a balance of reliable guaranteed income alongside flexible access to larger sums if needed.

To access your money in this way, you must be 55 years or older and have a defined contribution pension. When you approach retirement, you keep your pension savings invested and withdraw funds from your pension pot, or ‘drawdown’. Due to the fact that your money remains invested, which is often in the stock market, there is a chance that your fund may lose value. On the plus side, investment growth can result in better returns and an increase in the value of your pot.

But if you simply want a regular monthly income for the rest of your retirement, pension drawdown might represent too much risk.

What are the advantages of pension drawdown?

The main advantage of pension drawdown is the freedom to drawdown money as and when you need it, and receive tax benefits in the form of a 25% tax-free allowance.

Other advantages include

• You have the flexibility and freedom to drawdown money as and when you need it, for example, to pay for a holiday or upgrade your car
• You can withdraw up to 25% of your pension pot tax-free as a cash lump sum
• Any money in your pension pot stays invested and may grow in value (which can help off-set inflation)
• You can consolidate your pension into one pot.
• You can leave any remaining money as an inheritance when you die

What are the disadvantages of pension drawdown?

The main disadvantage of pension drawdown is the risk associated with investing your pension, this means the value of your pension pot can go up or down.

Other disadvantages include…

• You need to actively manage your pension pot to make sure it lasts your lifetime
• Withdrawal risk – this is twofold.
• If you withdraw too much pension income your pension fund could run out.
• The fear of a dwindling pension fund stops you from drawing your money, and you end up 25 years down the line with a large pot of money that you no longer have the time or inclination to do the things you want with.

So, if you’re wondering ‘is pension drawdown right for me?’ there really isn’t a right or wrong answer. You just need to understand how different types of pension work and choose the right one for you. Getting independent financial advice can help you understand your options. Keep reading to learn more.

Is pension drawdown a good idea?

If you want the freedom to access your pension pot as-and-when you need it, pension drawdown gives you that flexibility. Whether drawdown is a good idea will depend on your individual circumstances and retirement plans.

Jargon Free Zone

We believe in keeping things clear and simple. Understand the difference between defined benefits and defined contributions with our box-and-barrel explanation.

What’s the difference between pension drawdown and annuity?

The key differences between pension drawdown and annuity are related to:

• how flexibly you’d like to access your money

• your appetite for investment risk
• whether you hope to leave an inheritance, known as a death lump sum
• how you perceive your pension pot

One other downside of drawdown pensions is the impact it has on how much you can continue to pay into your pension tax-free. Keep reading for more info on that.

Can I drawdown my pension before I’ve fully retired?

Yes. Sometimes people feel they need to retire but don’t want to go the whole hog. So they ease into retirement by reducing their hours, or by switching to a less time-intensive role.If you’d like to do this, you can use pension drawdown to replace some of your earnings with retirement income. This is known as ‘phased pension drawdown’.

How much can I withdraw from my pension in one go?

There’s no limit on what you’re allowed to drawdown from your pension in one go.  The Pension Freedom rules – which came into effect in 2015 – allow ‘flexi-access drawdown’, which means it’s up to you to decide what to do with your money.

Depending on your circumstances, you could:

• Withdraw all your money at once (for example, to buy an annuity from an Insurance company)
• Withdraw lump sums as you need them (for example, to allow you to access more of your pension pot during the early / active stage of retirement)
• Drawdown a regular monthly income or annual amount

It’s really up to you. However, given the significant impact on your retirement income and lifestyle, it is highly advisable to seek independent financial advice to help you decide how to manage your money.

At Joslin Rhodes, we’re retirement and pension planning experts, authorised and regulated by the Financial Conduct Authority. We’re not like your usual stuffy financial advisers who are only interested in dry facts and figures. We take a holistic approach to pension planning, that looks at what you want to do in retirement then works out how to achieve it financially.

We’ll give you money confidence to live later life to the full, and enjoy a comfortable retirement, without any niggling concerns about whether your pension pot will last.