You may nod your head to indicate understanding when you hear your friends, family or colleagues mention their ‘drawdown pension’.
But we’re often asked the question: “What actually is a drawdown pension?”. And it’s a perfectly sensible one to ask, as it can be complex.
If you’re considering a drawdown pension as a way to provide your retirement income, you need to plan carefully.
That’s why it’s so important that you seek high-quality professional financial advice about drawdown pensions when retirement planning and during (what should be) regular pension reviews.
What is drawdown?
A drawdown pension is one of the main options for accessing your pension savings in retirement.
You can convert your pension to a drawdown pension from the age of 55, which could result in your money being invested for longer.
Equally, though, you can take your pension flexibly, withdrawing money whenever you may need or want it.
Drawdown pensions were introduced as an alternative to annuities and other pension options, and because of demand for more control over their retirement investment from people with larger pension funds.
Income drawdown lets you take from – or ‘drawdown’ on – your pension, without accessing all of your retirement savings at once.
Any money you don’t take out remains invested, giving you the opportunity to keep growing your pension after you’ve retired.
What are the drawdown pension rules?
All new income drawdown pension arrangements set up after 6 April 2015 – when the pension reforms were introduced to give people greater choice and flexibility – are known as ‘flexi-access drawdown’ pensions.
You can take up to 25% of your flexi-access drawdown pension savings upfront tax-free.
There are also no limits on how much income you can withdraw from your remaining pension savings.
So, you could, for instance, withdraw it all in one go. Or take regular monthly or annual payments. Or even take a series of lump-sum payments, as and when you want them. It’s up to you – although, as we explore in more detail later, there could be tax implications depending on the approach you take.
What were the old drawdown pension rules?
If you took out a drawdown pension before 6 April 2015, you will have had one of two options: a Capped drawdown pension; or a Flexible drawdown pension.
A Capped drawdown pension limited the amount you could draw from your pension pot, in line with government restrictions.
A Flexible drawdown pension allowed you to take as much money as you wanted each year. But, to qualify for one of these types of drawdown pension, you had to be receiving more than a certain amount of pension income a year from other sources.
If you’re already in a Flexible drawdown pension plan, this automatically converted to flexi-access drawdown when the new pension rules were introduced in April 2015.
If you signed up to a Capped drawdown pension plan you have set up under the old rules, you have two options.
You can either convert to flexi-access drawdown pension or keep your Capped drawdown pension.
Since April 2015, Capped drawdown is no longer available for people taking benefits from their pension fund for the first time.
How does a drawdown pension work?
You can start accessing your personal or workplace pension as soon as reach the age of 55.
You can take up to 25% as a tax-free lump sum or take 25% of each withdrawal tax-free.
It’s therefore important to consider – as part of retirement planning – how much you withdraw from your drawdown pension, and when you do so, to ensure you don’t move into a higher tax bracket.
To give you an example, if you have a pension fund with a value of £500,000, you can take £125,000 of that as a tax-free lump sum.
You’ll then be left with £375,000 to invest via drawdown.
Your tax-free amount doesn’t use up any of your personal allowance. But, once your withdrawals go past this threshold, you’ll be required to pay income tax.
The amount you choose to withdraw in any given tax year will determine how much tax you pay – so, you could end up having to pay a higher rate or additional rate tax if you withdraw too much too soon or have other earnings.
To put it into context, if you withdraw a further £100,000 in a single year, you’ll have to pay the higher rate tax of 40%. Withdrawals of more than £150,000 will incur a tax rate of 45%.
Why might a drawdown pension be right for you?
A drawdown pension gives you flexible access to your pension as and when you want it. Hence the reason for the name ‘flexi-access drawdown pensions’.
The pension freedoms introduced in 2015 opened up drawdown to a far wider number of people than before, removing the need to purchase an annuity if that option isn’t right for you.
Millions of people have enjoyed the considerable benefits of flexi-access drawdown pensions since they were brought in.
We’ve listed some of the great advantages of these drawdown pensions below:
- Flexibility. You can choose to withdraw money when you like (bearing in mind the tax implications we covered above) and whether to buy an annuity or an alternative retirement product with your savings at any point
- Tax-free cash. You can take out a tax-free lump sum or drawdown sums when you choose. Plus, all funds that remain invested in a drawdown pension retain tax-free investment return
- Growth opportunities. Because your pension remains invested after retirement, there’s the opportunity for it to keep growing
- Choice. There is a range of drawdown pensions available from a wide variety of providers trusted by Sage. The inherent flexibility of drawdown pensions also means that we can help your switch providers if you want to
- Inheritance Tax benefits. If you were to die before the of 75 but had already begun to access your drawdown pension, it’s possible for your beneficiaries to access your fund as a tax-free lump sum or opt to receive drawdown payments tax-free
- Control. Annuities are very attractive propositions in themselves, but you may not want to be locked into one at certain interest rates. You can use a drawdown pension while you wait for the right time to buy an annuity (if you want to buy one at all – there’s no obligation to do so)
Some things to consider before opting for a drawdown pension
Drawdown pensions are a great option. But they’re not for everyone.
As with everything in life, you have to weigh up the balances before choosing to take out a drawdown pension.
As we highlighted during the introduction to this blog, it’s vital that you take the expert advice of an experienced and trusted adviser rather than leap into a drawdown pension feet-first (as attractive an option as they might be). You should also review your pension on a regular basis.
An adviser will be able to identify why a drawdown pension might be right for your circumstances – or why it might not be. They will guide you through your retirement planning and pension options, and give you the kind of valued advice that will help secure your financial future.
For example, while an annuity provides you with a guaranteed income for the rest of your life, a drawdown pension won’t, because the pot is finite.
And, because the pot is finite, there is the possibility – though a good financial adviser will help you steer well clear of this scenario – that if you drawdown too much money or your investments underperform, you could run out of cash.
Again, your financial adviser will use their pensions expertise to help you build a balanced drawdown portfolio that reflects your needs and attitudes to risk appetite, but your drawdown pension and income could be impacted if your investments don’t perform as well as you’d like them to.
While paying tax on an annuity is a relatively straightforward business – and can be in the case of drawdown pensions if you consult a good financial adviser – there is the potential to pay too much tax if you lose sight of hope much you are drawing from your drawdown pension. Again, this won’t be a problem if you use a good adviser.
Make sure you get expert drawdown pensions advice
We can’t stress enough how important it is to for you to talk to an experienced adviser with pensions expertise when assessing the benefits of a drawdown and pension and weighing up if it’s the right option for you and your circumstances.
A drawdown pension is a great option for many people but a financial adviser will also help you compare the pros and cons of other retirement planning options.
Your adviser will also add real value when it comes to guiding you in building a balanced drawdown portfolio designed to help your pension investments withstand or benefit from market changes.
Your financial adviser will also help you manage your drawdown pension withdrawal strategy, and ensure that you don’t end up paying too much tax.
Why speak to Sage about your drawdown pension?
Planning ahead for your retirement and assessing your pension options as early – and as regularly – as possible will help you to build a more comfortable and enjoyable financial future.
Great service is the cornerstone of our approach. We see each of our clients as unique and deserving of a bespoke service tailored to their own financial needs and future aspirations.
And, as part of St. James’s Place Wealth Management, Sage Wealth Management is able to offer a complete package to clients in all aspects of financial planning.
We work closely with all clients to build a relationship based on trust and an in-depth understanding of their personal finances, whether that be in relation to their pension planning or other needs.
Please get in touch today to understand your drawdown pension or other retirement planning options.
The levels and bases of taxation and reliefs from taxation can change at any time.