What Is Pension Drawdown And How Does It Work?

What is Pension Drawdown?

A pension drawdown is an arrangement by which you can remove money from your pension to support your lifestyle and keep you funded, while the rest of your pension pot stays invested, meaning that it has the potential to continue growing, but can also decrease in value with market fluctuations.

As opposed to an annuity, which provides regular, fixed payments for a period of time or the rest of your life, a pension drawdown is more flexible and can be organised in your preferred manner.

There is always a chance that you could be left with less money to draw down as an income than you originally banked on, so pension drawdown does come with some inherent risks to consider.

 

How Does Pension Drawdown Work?

There are two main options:

1. Take up to 25% of your pension pot as one tax-free lump sum when you move your funds into drawdown to give you a regular or occasional income.
2. Take a phased or partial drawdown, whereby you move funds into drawdown in smaller instalments with 25% of each amount being tax-free.

Your tax-free amount does not take any of your personal tax allowances, but once your withdrawals exceed this threshold, you’ll be subject to income tax.

It’s important to consider how much you withdraw from your drawdown pension, and when you do so, to ensure you don’t move into a higher tax bracket, but your financial adviser should be able to help with this.

 

What Are My Options For Taking Money From My Pension?

Under the government rules, there are some ways you can take your pension, depending on the type of pension you have and the options your policy allows.

With a defined contribution pension (most personal pensions and auto-enrolment pensions) you can either buy an annuity, take flexible income drawdown or some providers will allow a hybrid of both.

However, not all providers offer these options, and it’s worth checking your policy with a professional adviser.

 

Set Up a Flexi-Access Drawdown Plan

You can withdraw your 25% tax-free lump-sum or a set amount under 25% through Flexi-access drawdown. The rest of your funds will remain invested with your pension provider, so they still have the potential to grow, shrink or remain static depending on market fluctuations.

If you wish to reduce the impact of market fluctuations, you may consider moving your funds into a low-risk pension policy.

Although your pension funds may not grow as quickly in the low-risk fund, they will also not be as susceptible to drops in market performance.

If you take more than your 25% tax-free cash, then the value above the 25% and any future withdrawals will be subject to income tax.

 

Make Ad Hoc Cash Withdrawals

Through drawdown, you could continue to take money from your pension either at regular stages or on an ad-hoc basis.

Your pension provider may charge you for each withdrawal you make, so it’s worth bearing in mind the flexibility you want from your pension when setting up your Flexi-drawdown policy.

If you have other funds that do not charge you for withdrawals, it could be worth considering taking money from this source, rather than paying for each transaction from your pension.

Your pension provider may also have a limit on the number of withdrawals per year, so it’s worth checking before setting up the drawdown account. Speaking with an adviser will help you to make the right choices.

Please remember that a Flexi-access drawdown pension may not be like your bank account. You may not be able to take money as and when you need it.

The process could take a few days or even weeks, depending on the fund type and the amount you wish to withdraw.

 

Purchase a Pension Annuity

Purchasing an annuity was the primary choice for accessing your pension a few years ago. And whilst current rates are pretty low, some people like the security they provide with a regular income. There are a few options available when purchasing an annuity.

As an annuity is an irreversible decision, it’s advisable to seek professional advice on which type of annuity (enhanced, life, income tracker etc.) is right for you.

Some providers, depending on the value of your pension fund, will allow you to purchase an annuity with part of your funds and leave the rest in drawdown.

 

Withdraw Your Whole Pension Pot

We would never usually recommend that you take your whole pension pot in one go. The current full state pension is £165.34 a week*, and without your pension topping up your income, retirement could be challenging.

If you do wish to take the full amount, again, the first 25% will be tax-free, and the remainder will be added to any other income and taxed under the tax bracket you now fall into.

As we said, cashing in your whole pension savings pot can be very risky and can typically only be done over the age of 55 years old.

We would strongly recommend speaking with a professional adviser before making any decisions about taking money from your pension. *www.nidirect.gov.uk

 

Tax And Risk Implications Of Pension Drawdown

However you choose to take an income through pension drawdown, any funds you withdraw beyond the 25% tax-free threshold will be taxable as earnings for that tax year.

You will also need to decide where you would like to invest the remaining portion of your pension pot once it has been moved into drawdown.

This decision will depend greatly on your attitude to risk and how long you are willing and able to ride out the inevitable market fluctuations to give your funds the best chance of flourishing.

There are several variations of how to use flexi-access drawdown to fit your income needs, which are likely to change throughout your retirement.

Hilltop’s Pension Drawdown advice can provide the support you need to make an informed decision.

 

What Are the Limits to Pension Income Drawdowns?

Some of the first questions we get asked by clients first thinking about Pension Drawdown is how much money can I take, when can I take it and what are the limits?

Since Pension Freedoms were introduced in 2015, people now have a lot more flexibility with their pensions. While giving people the flexibility with their money, we believe advice is needed to ensure you don’t run out of money in later life.

Depending on your pension provider and pension type, there could be access restrictions with how you can access your money.

Many older pension policies do not offer flexible drawdown, and it’s worth checking your policy to see if you can drawdown flexibly before you consider this option.

Also, many pension providers will not accept transfers of less than £10,000 into a drawdown policy.

There are no specific rules regarding a minimum pot value, but due to the fees the providers can charge you for this, it’s not financially viable for them to offer the drawdown facility.

After paying out the fixed management fee and then any transaction charges the provider may charge, these charges could have a considerable impact on your small pension pot.

In these cases, values under £10,000 may need to be transferred out or purchase a pension annuity with the funds.

Regardless of how much is in your retirement pot, you qualify to take out 25% of your funds’ tax-free (the tax-free lump sum), and if you take any of the remainder, this will be taxed at your income tax rate.

 

Is Pension Drawdown a Good Idea?

Pension Drawdown is a popular way to access your funds, whether you’re looking for an initial lump sum or the flexibility to withdraw money when needed.

Pension drawdown can be particularly helpful if you are not yet ready to fully retire, for instance, if you intend to work part-time or if you have a significant pension pot (or other savings and investments) to supplement your income.

However, remember that the value of your pension pot is not guaranteed, and you could run out of money.

Running out of money could be a possibility if you live longer than expected, take out more money than planned in the early years of retirement, incur unexpected health issues and associated medical bills, or your investments don’t perform as well as anticipated. So we recommend taking pension advice to make an informed decision.

With pension drawdown, as your funds are still invested, you will also need to consider that potentially your retirement funds could drop if the market dips or crashes.

A financial adviser will check that your investments are at a risk rating you’re comfortable with and potentially switch to a more secure fund if necessary.

 

Pension Drawdown Frequently Asked Questions

 

Do You Pay Tax on a Drawdown Pension?

Any money that you take from your pension drawdown pot over the tax-free threshold will be subject to income tax, so anything over your initial 25% tax-free amount.

It is also worth noting that large withdrawals could push you into a higher income tax band. These are just a few more reasons to seek professional advice from one of Hilltop’s experienced advisers.

 

Do You Pay National Insurance on Pension Drawdown?

National insurance payments are only collected on income from employment or self-employment.

However, if you are below the state pension age, you will need to pay national insurance contributions if you earn above the minimum threshold.

After that, the only pension drawdown tax you will need to manage is your income tax.

 

How Do I Determine the Right Income Withdrawal Rate for Pension Drawdown?

The right income withdrawal rate for pension drawdown depends on your specific circumstances. It is important to remember that your pension savings need to last for the rest of your life.

Therefore, you should try to be prudent wherever possible and resist the urge to take too much too soon.

The best way to decide the most appropriate income withdrawal strategy is to speak to a financial adviser to ensure you are making an informed decision.

 

When Can You Drawdown Your Pension?

You could drawdown from a personal pension from your 55th birthday. In some circumstances i.e. ill health, your pension provider may allow you to take money from your pension, but this is at their discretion. Capital at Risk.

 

How Much Can I Drawdown?

You can withdraw the total amount that is held in your personal pension from your 55th birthday, subject to any restrictions from your pension provider.

But, always remember that these funds could be your only source of income in later life.

 

Is Pension Drawdown Classed as Income?

Yes, any income taken from your retirement fund will be classed as income. The first 25% of the value of your pension fund is classed as tax-free, any further withdrawals would be subject to your income tax rates.

Tax treatment depends on the individual circumstances of each client and maybe subject to change in future.

 

Do All Private Pensions Offer Pension Drawdown?

No, not all pensions offer the flexibility of pension drawdown, and it’s always advisable to speak with a financial adviser to find out if your policy offers flexible drawdown. Capital at Risk.

 

How Long Does Pension Drawdown Take?

If drawdown is available in your circumstances, it can take around three to four weeks to set a plan up.

 

How Do I Apply for Pension Drawdown?

Following an assessment with our advisers, if drawdown is recommended, we will send you a couple of simple forms to sign and we can set up the pension drawdown options for you.

 

Are There Any Charges for Pension Drawdown?

Pension providers could charge fees for withdrawing funds from your pension, so it’s worth checking the rates before agreeing to drawdown with certain providers.

With most of the pensions we recommend there are no additional charges for drawdown pensions. For more information, read our in depth guide on pension drawdown charges.

 

Is Pension Drawdown Better Than an Annuity?

An annuity is an insurance product that enables you to buy a fixed, guaranteed income for the rest of your life (or a specified period) using some or all of your pension pot.

If your investments perform well, pension drawdown could reward you with a bigger pension pot.

However, if you desire certainty, an annuity might give you more peace of mind. Read our in-depth guide on pension drawdown vs an annuity to learn more about these two options.

 

Are There Different Rules to Pension Drawdown Once You Hit 75 Years Old?

Depending on what pension plan you have and how you’ve accessed your pension so far, there could be different rules when you reach 75.

If you have a defined contribution pension, and you haven’t taken any funds yet, some older pension plans may stipulate that you need to purchase an annuity or withdraw the full amount in one go.

Even some pension drawdown plans have a rule that by the age of 75, you need to purchase an annuity.

Some pension drawdown providers also stipulate that you have to buy an annuity by age 75 if you have money left in your drawdown fund.

 

What Happens to a Pension Drawdown on Death?

Should you die before the age of 75 with all or some of your pension fund still invested, your pension pot can pass down to your beneficiaries tax-free, either through an annuity, lump-sum or regular income.

If you are 75 or over when you die, your pension savings pot can be paid to your beneficiaries but will be subject to income tax at the marginal rate.

Your beneficiaries can either draw money from your pension as an income or take the fund as a lump sum. Regardless of the scenario, our advisers can help you to plan an appropriate course of action to provide for family and friends after you die.

 

Who Are the Best Pension Drawdown Providers?

Most pension providers offer pension drawdown when it comes to your retirement funds – so seeking out the best drawdown pension providers can be a bit of a minefield.

Many firms implement drawdown pension charges, including fees for setting up a regular payment, fees for withdrawing your money and monthly fund management payments.

Before deciding on your pension drawdown provider, it’s worth checking across the market to see if you can get lower charges by moving your pension fund to a different provider.

In order to achieve the best deal and make the most of your savings, we highly recommend that you speak to a drawdown specialist, who will help you to put together a retirement and income plan to make sure you’re making the most of your pension fund.

Within the retirement plan, the adviser will help you to maximise tax efficiencies and how much you can realistically take out of your pension without running out of money.

You need to trust that your pension funds will be invested in a sensible manner, that you understand any charges involved and that you are always receiving the best possible advice.

 

What Else Do I Need to Know About Pension Drawdown?

Pension drawdown represents a flexible route to accessing your pension pot from age 55 onwards. Even if your current pension provider offers pension drawdown, you may enjoy better returns by shopping around on the open market.

There are also some pension drawdown charges to consider regarding the ongoing management of your pension drawdown scheme.

This is where the impartial advice of a Hilltop retirement planning expert can be highly beneficial. We can help you to formulate a robust plan for taking your money and avoiding running out of funds.