Pension drawdown: what is it - and does it come with tax implications?

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

Regardless of the type of pension you are savings into, pension drawdown offers 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. Though, it is important to shop around for the best drawdown deal.

There are pros and cons of using this strategy, and it won’t be suitable for everyone. So, what do you need to know before opting to do it? 

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Here's everything you need to know about pension drawdown.

What is pension drawdown?

Pension drawdown - which is 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 lifestyle in the here and now.

Upon reaching the age of 55 (57 from 2028), you are entitled to take up to 25% of your pension pot as a tax-free lump sum. From then on, you can continue to make withdrawals using drawdown whenever you wish. But these will be exposed to income tax, with the rate you pay determined by your earnings in that tax year, as well as your tax code. The remainder of your pension pot remains invested, meaning the value of it can go up as well as down.

When looking to set up drawdown, you have two main options. 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 drawdown, 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.

Is pension drawdown right for me?

Drawdown is not suitable for everyone. For starters, 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. With drawdown, you run the risk of depleting your pot prematurely. So, you must make sure your drawdown strategy aligns with your desired lifestyle.

Despite these potential drawbacks, drawdown can be an excellent option for certain individuals. An important factor to consider is the size of your pension pot. Citizens Advice recommends drawdown to those with a six-figure pension 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.

But remember, 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.

What are the alternatives to pension drawdown?

An annuity offers a guaranteed income for life in exchange for your pension pot. For some, knowing exactly how much you’ll be receiving for the remainder of your days is attractive. But annuities lack the flexibility offered by drawdown and rates are set to fall as interest rates drop.

However, it doesn’t have to be a case of opting for one product over another. You can mix and match. You can use part of your pension to secure an annuity, while moving the rest into drawdown to offer a more flexible income as and when you need it.

This strategy could cover essential living costs for the rest of your life, giving you peace of mind. It also allows you to benefit from any good returns - or shield yourself if things don't work out so well.