Pension drawdown explained

In this guide: All you need to know about pension drawdown, from how it works to what happens when you die and where to find expert advice.

How does pension drawdown work?

  • Your pension pot is invested in a tax-efficient investment fund that you choose yourself or with the guidance of an independent financial adviser. The most popular investment vehicle is a Self-Invested Personal Pension (SIPP).

If you wish, you can take up to 25% of the pot as a tax-free lump sum.

  • The balance of your pension pot stays invested, giving it the potential to grow provided your investments perform well.

You can then use this pot to give you a regular income, or simply take lump sums as and when you need them. Any money you withdraw will be classed as earnings for tax purposes.

  • Be aware, that the value of your investment can go down as well as up, so there is no guarantee that your pot will provide you with an income for life. Also, if you take out too much cash too soon, or you set your regular payments too high, you could run out of money.

If this is a concern, you might want to consider using at least some of your pension pot to provide an annuity alongside your flexi-access drawdown facility.

How can you access a flexible income in retirement?

If you’re aged 55 or over, you have the option to use 'flexi-access' drawdown to withdraw some of the money in your pension pot.

Under current rules, you can take up to 25% of your pot as a tax-free lump sum, and the rest stays invested in the way you choose.  You’re in control and are free to withdraw money as and when you need to. Each withdrawal over and above the first 25% will be taxed as earnings.

The more you take from your pension pot, the smaller it will get, unless your investment manages to outperform the amount you have withdrawn.

How much could I get if I drawdown my pension?

Here are some examples of pension drawdown combined with a level pension income annuity, based on a 65-year-old man with no health conditions and withdrawing the full 25% tax free sum:

Pension Pot 25% Tax free cash Pension Income
£50,000 £12,500 £1,955
£100,000 £25,000 £3,924
£250,000 £62,500 £10,022
£500,000 £125,000 £19,947
£1,000,000 £250,000 £40,248

Rates correct as at 1st March 2022

How can I set up flexi access drawdown?

1. Make sure your pension is with a provider that offers flexi access drawdown. Many SIPP providers do, so if your current provider doesn’t, you are free to shop around.

Remember, when making any decisions about moving your pension to a new provider, be on the alert for pension scams. Seek advice from a reputable professional adviser you trust.

2. Decide how much of your pension you want to move into your flexi-access drawdown account and how much, if any, you may use to buy an annuity.

Your choices will probably depend on how much income you are likely to need at different times in the future and what other income sources you have.

How much tax do you pay on pension drawdown?

After the initial 25% tax-free lump sum, any money you draw from your pension is liable for income tax at your basic rate.

HMRC will work out your tax rate and how much you owe based on the amount you have withdrawn plus any income you have received from other sources.  If you have drawn down a significant amount or receive a high income already, this could push you into a higher tax bracket.  To start with, HMRC will probably set up an emergency tax code for you.

When you start taking income from your drawdown fund, you can continue paying into your pension fund if you wish. The total contributions you can make in any given year will be limited to the money purchase annual allowance (MPAA) which is currently £4,000 per year, unless your drawdown income is 'capped'.

What is capped drawdown?

If you set up pension drawdown on or before 5th April 2015 and you haven't yet converted to flexi-access drawdown, you are automatically in capped drawdown.

This means the maximum amount you can take as income from your drawdown fund is limited to around 150% of the annual income you would get from a basic annuity based on the value of your fund.

This limit is reviewed every three years, changing to annually once you've reached the age of 75.

To convert from capped to flexi-access drawdown, contact your pension provider.

What happens to my pension pot when I die?

If you die before your 75th birthday, any money remaining in your pension fund will be passed to your beneficiary/ies tax free. If you are 75 or over, your beneficiary/ies will pay tax at their marginal rate of income tax.

Get pension drawdown advice from Age Partnership

Our chosen partner, the award-winning retirement income specialists Age Partnership, offer expert financial pensions and annuity advice to help you understand pension drawdown and your investment choices.

You adviser will be able to provide you with a completely personalised recommendation, to show whether drawdown would be right for you and help you.

Age Partnership can also compare annuities to find the best guaranteed income options for you.

So confident are they of finding you the best deals that they will give you £100 if you find a better like-for-like quote elsewhere.

Calculate your pension drawdown options now

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