What is pension drawdown – and is it right for you?

If you're heading towards retirement, you may be thinking about how best to access your pension pot.

If you’re saving for retirement into a defined contribution (DC) pension scheme, pension drawdown is one option for accessing the funds you've built up. It provides a way of accessing your pot flexibly, giving you the freedom to spend some of your money while leaving the rest invested.

Terms vary between providers though, so it’s important to shop around for the best drawdown deal.

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There are pros and cons of using this approach, and drawdown won’t be suitable for everyone.

What is pension drawdown?

Pension drawdown – sometimes known as income drawdown, or flexible drawdown – allows you to access your workplace pension savings or self-invested personal pension (SIPP), while leaving a portion of it invested. This gives you the option of continuing to accrue investment growth, while also funding your immediate lifestyle needs.

When you reach the age of 55 (57 from 2028), you’re entitled to take up to 25% of your pension pot as a tax-free lump sum. That’s the maximum you’re allowed to take. You don’t have to take anything at that point and you’re not obliged to take it all at once. We get into some of the different options available in this article.

The 25% rule applies per pension, so if you have multiple pensions gathered over a lifetime with different employers, each pot will have its own tax-free cash element.

When looking to set up a drawdown plan, you can either stick with your current pension provider or shop around.

Your current scheme may be able to convert your existing plan on your behalf, offering you continuity if you’re happy with the service you've been getting. But you might be able to get a better deal elsewhere. For example, you could enjoy lower fees, a broader choice of investment options or better levels of support. So, it’s always worth shopping around to see what’s available.

Consulting a financial adviser would be wise in this scenario. They’ll be able to assess the best way to manage your drawdown withdrawals by looking at your current financial situation, your retirement goals, as well as how you would like the remaining pot to be invested.

Once you’ve set up a drawdown plan, you can still hunt for better ways to manage your retirement money, say by changing your drawdown provider, or how often and how large your withdrawals are.

What types of drawdown arrangements are there?

From age 55, you’re allowed to take up to 25% of your pot as a tax-free lump sum but you don’t have to take it all at once – or even at all.

The more money you leave invested, the bigger the amount that will be left to grow through your stock market investments over time.

A single lump sum may be useful if you have a big outlay, such as paying off debt, helping out family or sorting out some big house renovations or a big holiday.

Depending on your provider, you may wish to take a gradual or phased approach.

In a drawdown plan, once you make a single lump sum withdrawal, it’s known as crystallising your pension pot.

What is flexi-access drawdown?

Flexi-access drawdown (formerly known as flexible drawdown) allows you to take up to 25% immediately, tax-free while the remaining 75% stays invested. There are no limits on how much income you can withdraw, but any amounts above the tax-free limit will be taxed at your normal marginal rate of income tax.

Once you take any taxable income from your pension, it triggers the money purchase annual allowance (MPAA), which caps the amount you can contribute into a DC pension each year to £10,000.

What is phased drawdown?

Phased, or partial, drawdown is not a product, per se, but a strategy that can help with gradual retirement. This lets you take money from your pension in smaller amounts, with 25% of each withdrawal taken without being taxed.

You can split your total pot into smaller pots, moving each into drawdown at different times, with each move allowing you to take up to 25% of that portion tax-free, keeping the rest invested or generating an income for you.

How is pension drawdown taxed?

The first 25% of your pension pot can be withdrawn tax-free, and this can be taken at once or over multiple withdrawals.

The amount you can draw from your pension in drawdown is capped according to two measures:

The lump sum allowance (LSA) that is capped at £268,275 – the total tax-free cash you can take from your pensions
Lump sum and death benefit allowance (LSDBA), which is capped at £1,073,100 – the total amount you can receive in your lifetime or that can be paid out to beneficiaries as a lump sum on your death.

Once you’ve moved into drawdown, any income or further withdrawals you make will be taxed at your regular (marginal) income tax rate.

Is pension drawdown right for me?

Drawdown is not suitable for everyone. Keeping your pension pot invested means there is continued exposure to risk. If you’re not happy with the uncertainty associated with investing during retirement, then drawdown may not be the right choice for you.

Similarly, drawdown does not offer a guaranteed income in the same way as an annuity. The income you receive will be dependent on the investment performance of your fund, so steer clear if you’re looking for something stable.

If you’re not particularly financially savvy, drawdown could be a burden. It requires a degree of engagement and financial knowledge to make the right decisions. Receiving financial advice also comes at a cost – albeit one that is very worthwhile if you're not fully clued up.

Another thing to think about is your own longevity – your pot has to last you, and you don’t want to run out of money prematurely.

Despite these potential drawbacks, drawdown can be an excellent option for certain people. An important factor to consider is the size of your pension pot. Citizens Advice recommends drawdown to those with a six-figure pot, or for people who have enough other regular income from savings or investments.

Likewise, if you anticipate having higher income needs near the start of your retirement, the flexibility afforded by drawdown means you can access a larger portion of your pot, perhaps to cover the final few years of a mortgage, before tapering it down to a lower level.

Drawdown can make sense when it comes to legacy planning, too. Any remaining funds can be passed on to your beneficiaries when you die, making it a great alternative to an annuity if leaving a legacy is important to you.

It’s also possible to mix and match, using part of your pension to secure an annuity while moving the rest into drawdown to give you a more flexible income as and when you need it.

Everyone’s financial situation and retirement goals are unique, so it is vital to fully evaluate your circumstances and seek financial help if you need to. Support can also be accessed through the government’s MoneyHelper scheme, and by having a free Pension Wise appointment.

Sam Shaw is a seasoned finance and business journalist, having held several senior roles across the business press throughout her career, including Editor of Financial Times Group's flagship B2B investment title.

She now works as a freelance writer, editor, content producer and presenter, across trade and consumer media, primarily covering finance, fintech and broader business topics.