The pros and cons of pension drawdown vary depending on your individual circumstances and retirement plans.
If you want the freedom to access your pension pot as-and-when you need it, pension drawdown gives you that flexibility. 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?
- 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 leave any remaining money as an inheritance when you die
What are the disadvantages of pension drawdown
- This type of pension exposes you to investment risk – the value of your remaining pension pot may go up…but it may go down
- You need to actively manage your pension pot to make sure it lasts your lifetime
- Withdrawal risk – this is twofold.
- Firstly, you draw too much, too soon and your pot runs dry.
- Secondly, fear of running out stops you 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.
What is pension drawdown?
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 cash lump sum (often called a pension commencement lump sum) but you must do something else with the remaining 75%.
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 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.
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
|Access and flexibility||You can’t access your full pension pot, you just receive agreed monthly payments||You can access any amount of your money, as and when you want to|
|Income||You receive a regular, predictable income for the rest of your life, or agreed term||You have no guaranteed income and need to actively manage your money|
|Risk||You are guaranteed a certain income – you have zero investment risk||The value of your pension pot may go up or down, depending on your investments|
|Inheritance||Your spouse may be able to continue to receive payments after you die, until their death, but usually there is nothing to pass on to children||When you die, your remaining pension pot can be distributed to your loved ones in the form of a death lump sum|
|Perception||You are more likely to perceive your pension as ‘income’ and be happy to spend it||You may perceive your pension as ‘savings’ and be scared to spend them|
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.
When can you take a pension drawdown?
You can take a pension drawdown anytime from the age of 55 onwards, making early retirement a tempting possibility for many weary workers.
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 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.
Considering early retirement?
Discover everything you need to know about retiring at 55 in the UK.
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 drawdown from my workplace 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.
Is pension drawdown classed as income?
In tax terms, apart from your 25% tax-free lump sum, any further drawdowns you make are classed as taxable income.
Is my pension drawdown taxable?
You can withdraw 25% of your pension pot as a tax-free lump sum. After that, any withdrawals are subject to tax. The exact amount of tax you’ll pay depends on your other sources of retirement income. For example, private and state pension, or income from investments. It’s best to speak to a financial adviser if you need help understanding your likely tax liability.
Assuming you have no other income from other sources:
- The first £12,500 is tax-free
- You pay basic rate tax at 20% on the next £37,500 above this
- Then 40% on everything over £50,000
- And 45% on everything above £150,000
With flexibility being one of the main benefits of this type of pension, you’ll probably drawdown different amounts in different years. This means your tax bill is likely to vary year-by-year. However, you usually don’t need to worry about that as your pension provider should calculate your annual tax liability. But be aware of the potential ‘emergency tax rate’ pitfall when you first drawdown.
How to avoid emergency tax on pension drawdown
People accessing their tax-free lump sum / pension commencement sometimes get a nasty surprise when they’re hit with a hefty tax bill from HMRC. Rest assured – this is a well-known issue, and you can apply to HMRC for a rebate. However, it’s best to avoid this situation altogether and save yourself the unnecessary stress and admin.
The reason this happens is because, when HMRC sees you drawdown a large amount of money, they assume this is going to be your monthly drawdown for the rest of the tax year. They put you on a temporary tax code, which results in an overestimated tax liability, often in the thousands.
The best way to avoid this problem is to drawdown a small amount of money BEFORE you take out a larger lump sum. This gives HMRC time to correctly adjust your tax code.
It can take HMRC up to a month to make this adjustment. So, if you want to access your lump sum ASAP, you might just have to accept the emergency tax code and claim a rebate later.
Can I keep paying into my pension once I’ve started drawing down?
Yes, you can keep paying into your pension once you’ve started drawing down. However, you get lower tax relief on pension contributions after you’ve started the drawdown process.
Before you start drawdown, you can usually get tax relief on up to £40,000 of pension contributions per year. But once you’ve started drawing down, this reduces to £4,000.
Can I leave my drawdown pension to family when I die?
Yes, one of the main benefits of a drawdown – compared to an annuity – is that anything left over when you die can generally be passed on to loved ones and other beneficiaries. The age when you die will affect the amount of tax they have to pay.
- If you die under the age of 75, your beneficiaries can inherit any remaining pension tax-free.
- If you die over the age of 75, your beneficiaries will pay tax on any pension pot you leave to them.
If you think you’ll have an estate to leave in your will, it’s worth talking to a financial adviser about estate planning advice, to make sure your wishes are carried out and any tax liability is properly managed.
Why might I be scared to spend my pension drawdown?
Earlier, we said that people are sometimes scared to spend their money when they have a drawdown pension. It’s all about perception.
When people have an annuity, they receive a fixed income every month. They know they can rely on these regular payments for the rest of their lives (or agreed term). They perceive it as income and – like earning a salary – they’re happy to spend it.
When people have a drawdown pension, they know they have a certain amount of money (give or take investment fluctuations) to last them for the rest of their days. They often perceive this as savings and – as a result – can be reluctant to spend it. This can lead to a less comfortable retirement, even though you have money in your pension pot.
That’s why getting independent financial advice is so important. At Joslin Rhodes, we’ll help you work out what you want to do in retirement and how much money you’ll need to achieve those dreams. You’ll have a firm financial plan for later life, to give you confidence in your spending and empower you to be emotionally prepared for retirement.
Is pension drawdown right for me?
Pension drawdown might be right for you if:
- You want the freedom to access your pension pot in different amounts at different times.
- You’re happy managing your money to make sure it lasts your full retirement.
- You’re comfortable with exposure to investment risk.
- You want to be able to leave money to loved ones.
Pension drawdown might not be right for you if:
- You want a regular retirement income stream that you can rely on until you pass away.
- You are risk-averse or hate the idea of having to actively manage your money.
Ultimately, only you can decide what’s right for you. As you’ve seen, pensions can be a little complicated. That’s why it’s a good idea to get independent financial advice. A good financial adviser can help you understand your pension options and what’s going to work best for you.
Want to understand if pension drawdown is the best route to a comfortable retirement?
To make sense of your pension options and get started on your journey to retirement, you can take our free no-obligation first meeting.
You’ll be able to speak with our financial advisers who can explain our PlanHappy Lifestyle Financial Planning process, how it can help you, but most importantly, you can work through what it really is you want to do in retirement.
You tell us what you want to do, you tell us your goals and aspirations, and then we start your journey to retirement.
✓ Retirement Savings – how much you need to save for retirement
✓ Retirement Date – when you can afford to stop working
✓ Retirement Income – how much you can spend in retirement
So, if you’re looking to make sense of pension and retirement planning options with straightforward financial planning advice, we’re here to help.
Contact our friendly team on, 033 0133 3035 or use the form below to arrange a call back from one of our experts.
Joslin Rhodes Pension & Retirement Planning – Real Advice, For Real People