How does pension drawdown work? How does pension drawdown work?

30 Sep 2021 | Comments: 0 | Author: Christina Bentley | Retirement

You have many options available to you when you reach retirement age. You may have heard of pension drawdown if you're a member of a defined contribution or DC pension plan. What is, however, pension drawdown and how does it work?

Not to worry. We’ll break it down into simple terms, explain how it works and the key things to think about as you weigh your options heading into retirement.

What is pension drawdown?

Sometimes called income drawdown or flexible retirement income pension, drawdown launched as an alternative to annuities in 1995. It gives you the opportunity to take or ‘draw down’ some or all the money from a pension pot as and when you need it.

To be eligible for pension drawdown you must be a member of a DC pension scheme and be age 55 or older.

How pension drawdown works

Pension drawdown is a type of retirement product. When you take a drawdown scheme, your pension pot savings move into what's called a pension drawdown fund. Your fund then moves to a group of investments such as the stock market. This gives the fund a chance to grow, but it also means its value can fall.

When you move your pension pot into drawdown you have the option to take up to 25% as a tax-free lump sum. Where you invest the remaining 75% is up to you. That’s why it’s vital that you get regulated advice on your attitude to risk, future goals and circumstances.

Unlike an annuity, drawdown offers full flexibility over how much you take and when you can take it. For instance, you can draw down money for home repairs or to maintain your lifestyle. But, keep in mind that what you take out can’t be reinvested back into the drawdown fund. That’s why it’s always wise to plan your spending and only take what you need.

How much does it cost?

You can usually take up to 25% of your pension pot as a tax-free lump sum when you reach age 55. Unfortunately, you'll need to pay income tax on any amount you take outside this tax-free allowance. How much tax you pay with pension drawdown will depend on where you live and the amount you take.

While pension drawdown offers more flexibility, it can involve several fees and charges. Pension drawdown schemes need regular maintenance. Other costs may include:

  • Initial set up fees
  • Transfer fees or exit charges
  • Ongoing management fees
  • Administration fees
  • Money withdrawal fees

Charges will vary from provider to provider and you must keep in mind that you’re not guaranteed to get what you put in. That’s why you must compare plans and their associated costs before committing.

Understanding pension drawdown benefits

Is a pension drawdown a good idea?

With many options available to you as a result of 2015’s pension freedoms, you may be wondering whether pension drawdown is better than an annuity.

Pension drawdown can be a good option if you’re looking for flexibility on how you manage and take your retirement income. But, pension drawdown isn’t for everyone and it might make more sense to consider an annuity if you prefer a hands-off approach.

We’ve outlined the pros and cons of each option below.

Pension drawdown pros and cons

Pros:

  • Full flexibility to take larger lump sums, increase or decrease your income
  • Your beneficiaries can inherit your remaining funds after you die
  • You can control and manage your tax liability each year
  • There’s a possibility that your invested funds will grow

Cons:

  • No guarantee that your invested amount will grow
  • You can run out of money
  • Investing means you’re at the mercy of the stock market
  • Drawdown schemes need management, either by yourself or a financial advisor
  • Management fees can eat into your fund

Annuity pros and cons

Pros:

  • You get a guaranteed income for life
  • Your income either stays consistent or rises annually
  • You don’t need to manage it once it’s set up
  • You can choose an annuity that offers increased income
  • Your income isn’t affected by the economy or stock market
  • Some annuities offer a reduced income for your surviving partner
Cons:

  • Annuity rates aren’t always generous
  • There’s no flexibility on how much income you can take
  • You can’t change your mind once you’ve purchased an annuity
  • Your loved ones can't inherit your annuity after you die

If you can’t decide between the two, consider both! It is possible to divide your pension pot into a chunk for an annuity and one for drawdown. Some people also decide to use the bulk of their savings for drawdown and buy an annuity later.

Of course, the choice is up to you. But if you want the reassurance that you’re considering all your options, it’s always wise to speak to a financial advisor.

Getting pension drawdown advice

Making an informed decision about your future

We hope that you have a better understanding of how pension drawdown works. But if you have more than one pension pot, or still aren’t sure what’s right for you, get financial advice. Is financial advice right for you - Do you need financial advice?

Planning your retirement comes with big decisions. With options like drawdown and annuity to consider, it can be difficult to know what’s right for your circumstances. That’s where financial advice comes in.
An advisor can help you consider the bigger picture, offering impartial advice on each option. If they think pension drawdown could work for you, they’ll help you choose the right product for your needs and compare the market.

If you think you could benefit from personalised advice, we can help you save valuable time. Our free service connects you with a local advisor with the right expertise for your needs. Here’s how it works:

  1. Tell us what type of advice you need
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  3. Enjoy a free consultation and discover your options

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