tel: 01173 823 823

leaf logo 3

What is Pension Drawdown

Leaf Financial Advisers – Bristol based Pension Advisors

What is Pension Income Drawdown

Drawdown is a popular method of accessing a pension, with its popularity mainly due to its flexibility and opportunities for growth and tax planning.  It is often referred to as Pension drawdown, Income drawdown, or Flexi-Access drawdown.

Drawdown allows you to leave your money in your pension savings pot and take income or lump sums from it as and when you please.  Any money which is left in your pension pot can remain invested, which gives your pension savings an opportunity to continue to grow.

You can usually take up to a quarter (25%) of your pension savings tax-free with any other withdrawals being taxed as earnings, whether you take them as an income or as lump sums.

This flexibility can allow you, for example,  to take a higher income when you first retire when you are planning to be more active and have higher expenses, and a lower income later on.  Or you may decide to take no money from your pension, and use other funds you may have (such as premium bonds) to let your pension pot continue to grow, tax-free and away from inheritance tax.  You are likely to spend 20 years or more in retirement and so you will need to decide how much to take at the beginning and when to take more.

It’s important to keep this plan under review as you get older to ensure your pension savings will last as long as you do.

It’s also important to remember that you do not have to take any income if you do not wish to do so.

If you have any questions about Drawdown or anything else involving pensions then please get in touch; we are Independent Financial Advisors and are always happy to help.

What are the Advantages of Income Drawdown

One of the biggest advantages of using drawdown for your retirement is the level of both flexibility and control it can provide.  It allows you to choose when to access and how much to withdraw.  This can be useful if you receive income from other sources as it can help you manage your tax position more effectively. And as the money remains inside your pension, you can retain the option of buying an annuity at a later date (although annuity rates can and do change).  There is also the opportunity to allow your funds to remain invested and potentially continue to grow.

There is also the opportunity to leave something for your family, to other beneficiaries of your choosing, or to charity.

As the money passed on through a pension is tax-free if you die before the age of 75 (and as long as you don’t exceed your lifetime allowance), it can be an effective way of looking after your loved ones after you are gone.  If you are over 75, then the remaining pension pot can usually to paid to your beneficiaries subject to their marginal income tax based on the individual tax position of the person receiving the money.

What are the Drawbacks of Pension Drawdown

The main drawback of using drawdown for your pension pot in your retirement is that the money remains invested, and this gives rise to uncertainty and risk about the future.

If your investments do not perform as planned then you may have to reduce your income or your pension savings could run out.  You also need to remember that your portfolio of funds that you have been investing in whilst growing your pension may no longer be appropriate when you are looking to take money out.

Holding your money as cash may seem to be less risky, but as the returns are generally lower than if you were to invest, then you have a different risk.   By choosing or staying in low-risk assets such as cash, this could increase your risk of running out of money in retirement or having less money than you were expecting, especially in times of high inflation

As such, you should therefore think very carefully about which funds you choose to invest in, taking into account your unique personal situation, your needs, goals, and attitude to investment risk. Drawdown gives you control, but this also means there is more responsibility for you when monitoring and managing your income. It is important to remember that money withdrawn from a pension is usually liable for income tax and withdrawing large sums could therefore mean you move into a higher tax bracket. If your circumstances change then there will remain the option to buy an annuity, which will provide you with a guaranteed income, usually for life.

An Alternative - One or several Lump Sums (UFPLS)

An alternative to using drawdown to access your tax-free element and taxable element when you wish is to spread your tax-free cash across all withdrawals and take a series of lump sums from your pension pot.

How does this work?  You access your pension pot by taking a series of lump sums, known as “Uncrystallized Pension Lump Sums”.  Uncrystallised as they are taken from the untouched part of your pension.

Each time you take money from your pension pot with a lump sum, 25% of it is tax-free and you may pay tax on the other 75%.

Please note that when taking your pension savings in this way your money purchase annual allowance (MPAA) will be triggered when you make your first withdrawal.  You must have some Lifetime Allowance remaining to be able to take your lump sum.

You are still able to take a different retirement option with any money remaining in your pension pot, including transferring it away to another provider.

An Alternative - Purchase an Annuity

A very different approach to using drawdown is to purchase an annuity.  In exchange for a cash lump sum, an annuity gives a regular guaranteed payment, often for life, although it can be for a set number of years.  Annuities come with a wide variety of optional features such as annual increases, guarantee periods, and payments made to a beneficiary.

Purchasing a standard annuity removes investment risk from your pension pot and is arguably a lot more straightforward to manage.  However, this simplicity must be offset against the benefits of drawdown, such as the flexibility and the potential for investment growth.

If you would like to find out more, please read our article on Annuities, or get in touch with us as we are, independent pension advisers and are always happy to chat about annuities or pensions.

Or do nothing, and leave your pension where it is

It’s important to be aware that in most situations you don’t have to start taking money from your pension pot when you reach your selected retirement age.  Pension pots can be deferred (take it later, often for a higher amount) or, if the pension type allows, it can remain invested indefinitely, until you choose to access it, or it is passed onto your beneficiaries via your estate.

However, please bear in mind that some pensions have benefits and features (such as a guaranteed annuity rate) that may be lost if the pension is not accessed by a certain point.

Leaving your pension pot where it is could allow your pot to grow further or increase the amount of pension income you are set to receive.  This means if you don’t need your pension pot now, and it is left to keep growing, you could have more money over a shorter period later.  Please be aware that your pot is still subject to investment risk and the amount you have invested may go up and down.

Final Thoughts

So is Flexi-Access/Pension/Income drawdown a good idea and the right way of accessing your pension savings?  

Generally, Flexi-Access Drawdown can be a very useful way of accessing your pension, allowing you the flexibility of when you access and how much you take out, flexibility about when you take your 25% tax free element, no limits on what you can take out, whether as an income or as lump sums, and all whilst still remaining invested and benefitting from the tax free wrapper.

However, there are drawbacks to Income Drawdown which much be taken into account.  Careful planning and monitoring of your drawdown pot will be required to make sure you are not only maximising your growth and tax savings, but to make sure you are not breaching any of the rules and regulations in place, the breaking of which can have severe consequences.  

If you remain invested then you will remain exposed to investment risk, and you may end up with less in your pension pot than planned.  This is usually dealt with by changing the types of investments your money is in compared to when you were building up your pension pot.

Whether drawdown is a good idea will depend on your individual circumstances and retirement plans.  A good financial plan can help you make the right decisions when it comes to your finances. Making the right decisions today to build a more prosperous future.

Choosing to use drawdown is 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.

If you are looking for a Pension Advisor in Bristol you can visit this link and we will be happy to help.