How does pension drawdown work? | moneyfacts.co.uk
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How does pension drawdown work?

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Michelle Monck

Michelle Monck

Consumer Finance Expert

At a glance

  • There are no limits on how much you can withdraw from a contributory pension
  • Once you use pension drawdown the amount you can save into your pension is reduced
  • 25% of your pension pot is available tax-free when using drawdown

What are the choices for your pension savings at retirement?

If your pension savings are in a defined contributions scheme you can choose to leave your retirement savings untouched and allow these to potentially grow further, buy a guaranteed income with an annuity or use pension or income drawdown. We explain more about pension or income drawdown in this guide.

What is pension drawdown and how does it work?

Pension drawdown rules mean that there are no limits on how much you can withdraw from your pension fund each year. You can take a tax-free lump-sum of 25% of your total pension pot up-front with your remaining pension savings left invested in your pension fund. Any income or withdrawals then made from your remaining funds would be taxed at your appropriate income tax rate. You can also choose to only make withdrawals from your pension as and when you want and not to receive the 25% lump-sum. In this case you would receive 25% of each withdrawal tax-free with the remainder taxed at your usual income tax rate.
Pension or income drawdown gives you the flexibility to access cash when you need it, with the chance that your remaining funds can continue to grow. You will need to carefully manage your withdrawals and monitor your pension fund growth to make sure you do not run out of money too soon.
The minimum age to access pension drawdown and not incur a tax penalty from HMRC is 55, however some pension funds may have a higher age so you will need to check with your provider. In 2028 the minimum age for drawdown set by the Government will increase to 57.
However, once you use pension drawdown the amount you can save into your pension will reduce from £40,000 or 100% of earnings (whichever is lower) to £4,000 per year.
You may need to transfer your pension to a flexible pension in order to access income drawdown from your pension savings. You should take advice from a financial adviser when considering a pension transfer. When you choose a flexible pension with income drawdown you can usually review how your money is invested and adjust your investment choices to match the level of risk you are happy to take.

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How to make sure your retirement savings lasts

When you use a pension or income drawdown this reduces the size of your pension pot and you could risk running out of savings during your retirement. You will need to carefully plan how much you wish to withdraw and monitor the performance of your pension fund to check you will not run out of money too quickly.
You can use the PensionWise calculator to find out how far your pension pot will go using pension drawdown.

How is pension drawdown taxed?

When using pension drawdown 25% of your total pension pot is tax-free. For example, if you had a pension pot of £80,000 and decided to only take a regular monthly sum of £1,000 form your pension, then £250 would be tax-free each month. The remaining £750 would be subject to tax at your usual rate. If you decided to take an up-front lump sum of 25% of your pension pot then this would be tax-free, with any future income then taxable at your appropriate rate of income tax.

Who are the best pension drawdown providers?

Every year Moneyfacts holds the Investment, Life and Pension awards, this recognises those providers delivering excellent products and great service to their customers. In 2020 the winner of the best drawdown provider was Royal London, with Prudential UK being highly commended and Standard Life receiving a commended award.

Who offers pension drawdown?

42 Self Invested Personal Pensions pension providers are listed by Investment, Life and Pensions Moneyfacts offer pension drawdown but fees and charges can vary significantly.

What are the fees and charges for pension drawdown?

There is no one approach to fees for pension drawdown with some providers charging set up, monthly and transactional fees, while some may not charge at all. Set up fees when charged are in the region of a few hundred pounds.

Pension drawdown and advice

You do not have to take financial advice when choosing pension drawdown. However, you may choose to do so to help ensure you make the most informed decision possible. There are risks with pension drawdown for example you may withdraw too much, too fast leaving you with no retirement income or the income you expect to earn from your invested funds is not as expected limiting your funds in later years. A financial adviser can put together a schedule for you to show you the different scenarios and how long your pension savings might last for.

What happens to my flexible pension after I die?

If you die while you are receiving a regular income from pension drawdown your dependents can choose to inherit this. If you are below 75 then they can receive this tax-free, if you are older than 75, they will need to pay income tax on this at their regular rate. They could also choose to use the fund to buy a guaranteed income with an annuity, and this would incur income tax at their usual rate.

Pension drawdown FAQs

Is pension drawdown better than an annuity?

Our guide Annuities vs drawdown which is right for you explains more about the pros and cons of annuities and drawdown.

How safe is pension drawdown?

From the perspective of earning a regular guaranteed income, pension drawdown can present more risk than an annuity. This is because once you buy an annuity your income is guaranteed for life, whereas with pension drawdown, your remaining funds are invested in the stock market, which could go up or down in value. If there is a fall in the value of your funds you could receive a lower level of income in the future. A financial adviser can help to identify how relevant pension drawdown is for you.

Is pension drawdown classed as income?

Yes, income drawdown from your pension is classified as income and is subject to income tax after your 25% tax-free allowance has been used.

When was pension drawdown introduced?

The new pension drawdown rules came into force in 2015.

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This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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