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What Is a Drawdown Pension?

Written by, Marija Petkova

Updated September, 2, 2022

There are many ways to withdraw money from your pension fund after retirement, including opting for a flexible drawdown pension plan.

But, what is a drawdown pension, and is it the right option for you? 

Let’s find out.

What are drawdown pensions in the UK?

An income drawdown is a way of accessing your pension funds while leaving money in your pension pot to remain invested. Even if you think to cancel your pension and get the money, with a drawdown pension you can draw a retirement income and let the remainder of your pension fund potentially benefit from investment growth.

The biggest benefit of drawdown pensions is that they are flexible. They can be taken on an ad hoc basis or set up to provide you with a regular income. 

There’s always a risk that your pension value will drop and there’s no guarantee that you will receive an income from the pension pot for the rest of your life.

Pension Drawdown Rules – How Does It Work?

To access money in your pension pot through pension drawdown, you must be 55 years old or older and have a defined benefit pension plan.

Income drawdown pension rules used to be stricter but, since the passing of the pension freedom rules in 2015, there are very few withdrawal limits. 

Entering a pension income drawdown usually allows you to withdraw a tax-free lump sum of up to 25% of your pension pot and put the remaining of your retirement funds into an income drawdown account (also known as partial or phased drawdown). Any amount that you take from the pension pot is taxed as income.

You can set up a drawdown plan with your existing provider or switch providers for more pension drawdown options, which might come with some extra fees.

The most important thing when entering an income drawdown is managing your withdrawals so your pension fund can last throughout your retirement.

Is Pension Drawdown for Me?

Income drawdown is a great option if you want:

  • The opportunity to grow your pension pot.
  • The freedom to withdraw funds whenever you choose.
  • To take several lump-sum payments to pay off short-term loans.
  • To take regular monthly or annual payments.

Income drawdown might not be the best choice if you:

  • Are looking for a guaranteed annual income.
  • Don’t want to risk running out of pension funds.
  • Want to avoid investment risk.
  • Haven’t completely retired or have loans to pay.

Benefits and Risks of Income Drawdown

Pros:

The largest advantage of entering income drawdown is that it’s flexible.

  • Flexibility ⇒ Income drawdown gives you the freedom to manage your pension pot as you see fit, including how much and how often you withdraw money from it.
  • A tax-free lump sum ⇒ You can get up to 25% tax-free lump sum of your pension pot, provided that you have a defined contribution pension. Amounts that surpass this percentage are taxed at your marginal tax rate. 
  • Potential to grow pension pot ⇒ The funds that remain in your pension fund can benefit from investment growth over a long period.

Cons:

Its largest disadvantage is that your pension might lose value over time.

  • Market turbulence ⇒ Your pension fund’s value will depend on the market situation. The level of income can change due to fund performance and the money in the pension pot can be depleted altogether.
  • Money Purchase Annual Allowance (MPAA) ⇒ The maximum amount you may put into your pension pot each year is £40,000. Your annual limit drops to £4,000 once you withdraw money from it. 
  • Durability ⇒ Entering income drawdown means that you’ll have to make sure that you set monthly or annual payments that can last for the rest of your life, which can be tricky.

What Happens to My Pension Drawdown Plan When I Pass Away?

Anyone who enters an income drawdown can name a beneficiary to withdraw the remainder of the funds in case of death. The rules vary depending on the age of death. 

Under 75 years old ⇒ If the person who set up the income drawdown pension is younger than 75 years old, the beneficiary can withdraw the funds without paying taxes. 

Over 75 years old ⇒ If you die after the age of 75, the beneficiary will be subject to pension drawdown tax.

Depending on your income drawdown plan, beneficiaries can withdraw the remaining pension funds as monthly payments, annual income, or withdraw them as a single amount.

Pension Drawdown Alternatives

Income drawdown is just one of the many ways you can withdraw funds from your retirement savings.

One-off Lump Sums

Other than setting an income drawdown plan, you can withdraw funds from your pension pot by making ad hoc transfers from your retirement regularly. You can withdraw the entire sum all at once or take a series of smaller lump amounts. 

Annuities

Another option to withdraw money from your pension is to purchase annuities. You can use your pension resources to buy a guaranteed income for the rest of your life or buy an annuity with a portion of your pension while keeping the remainder in income drawdown.

Bottom Line

What is a drawdown pension? It’s one way to take funds from your pension pot that gives you the flexibility to manage your pension funds and potentially benefit from investment growth without wondering how much money will you need to retire. That said, entering income drawdown is not for everyone and you should seek help from a pension expert if you’re not sure what the right option is for you.

My name is Marija, and I'm a financial writer at DontDisappointMe. Although finance might not be everyone's cup of tea, my 10+ years of working in one of the biggest banks in my country, and my interest in extensive research on everything finance/investment-related, have made me somewhat of an expert in the field (if I do say so myself). No longer having the passion to work in a corporate setting, I decided that I couldn't let all of this knowledge go to waste so I started writing. And, here I am! Today I try to share my knowledge with my audience in the hopes of making this topic as simple and interesting as possible. In my leisure time, I like spending time with my family and travelling to new locations.