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Understanding pension drawdown and if it’s right for you

Understanding pension drawdown and if it’s right for you
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If you are close to retirement, you may be wondering what pension drawdown is and whether it’s right for you. Pension drawdown is a method for accessing a pension. It gives you some flexibility over how your pension is used to provide you with an income. Let’s take a look at the details.

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How does pension drawdown work?

You will need to be aged 55 or over and have a defined contribution pension. Pension drawdown allows you to take some or all of your pension as income. The money remains invested in the stock market, so it may fall or rise in value.

Most of the money withdrawn from the drawdown fund will be treated as income and will be taxed accordingly. One of the main advantages of pension drawdown is flexibility.

There are a number of different options available to you when retirement planning. This means that you will need to make some important decisions.

What decisions do I need to make?

Tax-free lump sum

Up to 25% of your total pension pot can be taken tax-free. That means that 25% of any regular drawdown income will be will not be taxed.

Only the remaining 75% will be treated as income and taxed at the normal rate depending on your circumstances.

This may influence your decision on the drawdown amount so it’s a good idea to work out how much you need first.

Drawdown amount

Since 6 April 2015, pension providers have offered flexible drawdown. So if you are wondering what the maximum pension drawdown is, the answer is that there is no limit. You could choose between taking regular payments or withdrawing it in one go.

Bear in mind that if you withdraw the total amount, it will be taxed accordingly. Such a withdrawal could leave you with a hefty tax bill.

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Annuity

If you want a guaranteed income for the rest of your life, you can use some of your pension pot to buy an annuity. An annuity is a retirement product that will pay you a regular income for a fixed period or for the rest of your life.

An annuity is good for people wishing to avoid the extra responsibility of investing their income drawdown funds. It also gives you peace of mind that you will receive an income for a set period.

It’s a common misconception that you have to choose between an annuity or drawdown. Not only can you combine the two, but you can also choose to start with pension drawdown and then buy an annuity later.

What about a blended approach?

You could choose a combination of options. The right blend will depend on the size of your pension pot, your lifestyle and your attitude to money. In some ways, a blended approach is the ideal solution because it can work on a number of different levels.

For example, you could use some of your 25% lump sum to pay off any outstanding debts, such as a mortgage. This would enable you to start retirement debt free.

You could then use some of your pension to buy an annuity that pays your essential bills. This will give you peace of mind that the essentials will be taken care of no matter what.

You could then drawdown some and use this for additional expenses, such as trips abroad or helping your children.

Finally

It’s a good idea to think about your retirement in advance. You will need to plan your finances and make some decisions about your lifestyle and expenses when you stop working.

Seek professional help where necessary and do some additional research. Good sources of information include the Money Advice Service, Citizens Advice and the Pensions Advisory Service.

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