This guide will explain what pension drawdown is, how it works and whether it can help you to maintain a pension pot that will meet your retirement needs. It will answer important questions about new rules, charges and pension drawdown tax implications.
How does pension drawdown work?
Pension drawdown allows you to withdraw some of the money from your pension pot while keeping the rest invested to provide you with an income that can be paid regularly or as an annual lump sum. Also called income drawdown, it is an alternative to buying an annuity, which would guarantee you an income for life but mean your money is no longer invested.
The income you receive will depend on the performance of your funds. If the underlying investments do well, both your pension fund and your retirement income can increase. But the arrangement is not risk-free and if your investments perform badly, the value of your income and your pension fund could go down.
You are eligible for pension drawdown if you are aged 55* or over and belong to a defined contribution scheme or plan – one that you will have paid into and to which your employer might also have contributed – or have a personal pension such as a Sipp (self-invested personal pension).
So the first thing you need to check is whether your provider offers flexible access. Research by Profile Pensions shows 90pc of plans do not allow customers flexible access to their cash from 55**.
If that is the case you can still transfer your pot to a flexible scheme, but even if your provider offers flexi-access drawdown, you may want to consider taking independent pension advice first.
(*The minimum age for eligibility is set at 10 years below the present state retirement age of 65. When the latter rises to 67 in 2028, the minimum age for pension drawdown will increase to 57.)
Your pension drawdown choices
There are two main types of drawdown pensions: those set up after 6 April 2015 are flexi-access drawdown plans; those set up before that date are capped drawdown plans.
With a flexi-access plan you can withdraw up to 25pc of your pot as a tax-free lump sum and there is no limit on the income you can take.
With a capped plan you can also withdraw 25pc of your pot as a tax-free lump sum but the income has an upper limit equivalent to 150pc of an annually calculated Government-set annuity. However, if you have a capped drawdown plan you may be able to transfer to a flexi-access drawdown plan.
When it comes to choosing a scheme you will want to consider how much flexibility you need. Extra flexibility can often mean extra pension costs, for example if you want to change the income you take or withdraw sums on an ad hoc basis.
So before you decide which pension drawdown provider to go with, compare charges and flexibility. If possible, take independent advice to help you check your pension.
Pension income drawdown vs annuity
Income drawdown can be an expensive option but it could be the more suitable choice if you do not need or want to take all of your pension immediately, for example if you are planning to carry on working part-time or if you have income from other savings or investments.
An annuity offers peace of mind, because of the guaranteed income for life, but does not have the flexibility of pension drawdown.
A third option would be to use part of your pension fund to purchase an annuity, either at the outset or a later stage.
Whatever you decide, there are some important pension drawdown rules to note.
What are the rules for pension drawdown?
* You can take up to 25pc of your pension pot as a tax-free lump sum and you can do this up front. Some older schemes might let you take more. You don’t have to take the 25% all at once. You can make partial withdrawals and use the 25% tax-free cash more gradually.
* Once you start taking income from a pension drawdown scheme, and if you have no other income sources, after your 25% tax-free lump sum is taken, the first £12,500 you take in any year is also tax-free. After that you start paying income tax at the following tax rates (applicable in 2020-21):
20pc from £12,501 to £50,000
40pc from £50,001 to £150,000
45pc from £150,000 and upwards
(You can claim back any tax you think you have overpaid through the Gov.uk website. To do this, you will need to register for a Government Gateway user ID and password.)
Pension drawdown example
Suppose in the 2020-21 tax year that you take £60,000 from pension drawdown and have no other income from private or state pensions and you have already used your 25% tax-free allowance.
You wouldn’t pay any tax on the first £12,500
You would pay income tax at a rate of 20pc on the next £37,500 (£12,501 to £50,000) = £7,500
You would pay income tax of 40pc on the next £10,000 (£50,001 to £60,000) = £4,000
This would give you a tax bill of £11,500.
Do I need financial advice to use pension drawdown?
While it isn’t mandatory to get financial advice, it’s always wise to seek professional independent pensions advice before you decide on pension drawdown.
- Sign up with the Telegraph Media Group Pensions Advice Service and get a free pension investment recommendation in 10 minutes
- How do I find my pension from years ago?
- What happens to your pension when you die?
- What is the best pension for self-employed workers?
Capital at risk. Past performance is not a guide to future performance. This website does not constitute personal advice. If you are in doubt as to the suitability of an investment, please contact one of Profile Pensions’ advisers. Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change.
A one-off fee of 1.95% is only payable to Profile Pensions if you decide to accept the pension investment recommendation and transfer your pension(s).
Telegraph Media Group Limited is an Introducer Appointed Representative of Profile Pensions, a trading name of Profile Financial Solutions Limited, which is authorised and regulated by the Financial Conduct Authority. FCA Number 596398. Registered in England & Wales, Company Number 07731925. Registered office address: Norwest Court, Guildhall Street, Preston PR1 3NU.
**3833 pensions reviewed between January-July 2020
Information correct at date of publication.
The above article was created for Telegraph Financial Solutions, a trading name of The Telegraph Media Group. For more information on Telegraph Financial Solutions click here