Pension drawdown is a way of accessing the money in your defined contribution pension pot once you reach retirement. Instead of taking your entire pension as a lump sum or buying an annuity to provide a guaranteed income for life, pension drawdown allows you to keep your pension pot invested while withdrawing money from it as needed.
Here’s how it works:
- Tax-free lump sum: You can withdraw up to 25% of your pension pot as a tax-free lump sum at the start of your drawdown. The remaining 75% stays invested, and any withdrawals from this portion are subject to income tax.
- Flexible income: With pension drawdown, you have control over how much and how often you withdraw money. This flexibility lets you adjust your income to match your needs, whether you prefer regular monthly payments or occasional lump sums. However, it’s important to be cautious with withdrawals because taking too much too quickly could deplete your pension savings, especially if investment returns are poor.
- Investment growth: Since your pension remains invested, there’s the potential for it to grow. However, your pension value could also fall if investments perform poorly, which adds a level of risk compared to the certainty of an annuity.
- Income tax: Withdrawals from the taxable portion of your pension pot are treated as income and taxed according to your income tax rate. Careful planning is essential to avoid large tax bills, especially if withdrawals push you into a higher tax band.
Pension drawdown offers a flexible way to access your pension savings, but it requires ongoing management to ensure your money lasts throughout retirement. It’s often beneficial to consult a financial adviser to create a sustainable drawdown strategy tailored to your needs and investment goals.
You can read more about this in post-retirement financial advice guide.
