What is a Drawdown Pension?

There are many elements to understand about Pensions. One of the questions we get asked most frequently is ‘What is a drawdown Pension?’. Well, there are a variety of ways that you can take your Pension when it’s your time to leave the world of work and enjoy your retirement. Drawdown is an option you could consider.

Throughout this piece, we’ll run you through everything you need to know about drawdown Pensions, how they work, their tax implications and whether they’re a good idea. Here’s what you can expect from our guide:

• What is a drawdown Pension?
• How does a drawdown Pension work?
• Can I continue to pay into a drawdown Pension?
• Do you pay tax on a drawdown Pension?
  • Is a drawdown Pension subject to Inheritance Tax?
• Can you draw down a final salary Pension
• Can I transfer my drawdown Pension to another Provider?
• Are drawdown Pensions protected?
• Is a drawdown Pension a good idea?
• Do you need a financial adviser for Pension drawdown?

What is a drawdown Pension?

 A drawdown Pension is one way of using your Pension pot to provide you with a regular retirement income, or for withdrawing lump sums. You may also see it referred to as a flexible retirement income. It is used by some as an alternative to buying an annuity, which pays a guaranteed income either for life or over a pre-agreed number of years.

With a drawdown Pension, you can choose to withdraw from your pot as much as you like, with no restrictions. This offers you plenty of flexibility but also means you’ll have to keep track of what’s left in your Pension so that it doesn’t run out. The money remaining in your pot will continue to be invested in funds designed specifically for this purpose.

When you start Pension drawdown, it means you can access money to live on, while still leaving money invested to potentially grow further and fund your future. However, as with all investing, the longer you can stay invested and not touch your Pension, the more opportunity for potential growth you . With investing, your capital is at risk.

How does a drawdown Pension work?

A drawdown Pension is usually only available to people aged 55 and over. And from 2028, the normal minimum Pension age will increase to 57. With a drawdown Pension, you can withdraw up to 25% tax-free while the remainder of the pot will be invested. You can then decide if you want a regular income or amounts as and when you need them.

It’s important to remember that Pension and tax rules can change, while the value of your invested pot can go down as well as up, which means the income isn’t guaranteed and you could run out of money.

When it comes to withdrawals, you have two options:

Withdraw 25% as a tax-free lump sum

You can normally choose to take up to a quarter of your Pension pot as a tax-free lump sum. Some older Pensions might let you take more than 25%, so it’s worth checking with your provider.

Typically speaking, though, if your pot stood at £200,000 you could withdraw £50,000 tax-free. The remaining £150,000 would be invested and would be liable for income tax.

It’s important to ask yourself if you need the full 25% tax-free lump sum. If you choose to withdraw the lump sum when it is not needed and you leave it sitting in the bank, inflation rates may mean that, over time, your hard-earned money could lose value.

Keep 25% of each withdrawal tax-free

The other option is to do what is known as a partial or phased drawdown. This is where 25% of the amount you withdraw is paid tax free and the rest is taxed as income. As an example, if you were to withdraw £2000 each month, £500 would be paid as tax free cash and the remaining £1500 would be classed as a taxable income payment. The amount of tax deducted would depend on your individual tax code.

Whether you choose to take the 25% tax-free lump sum or not, you can move your Pension into one or more funds within a flexible access drawdown that allows you to take an income at times to suit you. 

Can I continue to pay into a drawdown Pension?

Yes, you can still pay into a drawdown Pension. Typically, you can contribute up to £60,000 a year into your Pension pot without paying tax. For most people, the annual allowance is currently the amount of your salary or £60,000 – whichever is lower. Unless you earn £0 to £3,600, then you can pay in £2,880 tax-free. However, once you start to make tax-free withdrawals from your drawdown, your Money Purchase Annual Allowance (MPAA) will kick in. This means you can only contribute £10,000, with anything over that threshold being liable for tax.

The amount you can pay into a Pension tapers if you breach both the threshold income and adjusted income limits. The allowance will continue to be reduced by £1 for every £2 an individual’s ‘adjusted income’ is over £260,000 and can still affect you if your income from all sources is over £200,000.

Contributions larger than the annual allowance can also be permitted by using carry forward – bringing unused allowances from the three previous tax years into the current year. The annual allowance for the 2024/25 tax year is £60,000.

It’s very important to check that you have worked out the correct annual allowance amounts available for carry forward. When you’re using carry forward, you’re working out the unused annual allowance not unused tax relief.

Pension eligibility and tax rules apply.

Do you pay tax on a drawdown Pension?

Yes, anything above the 25% tax-free threshold will be subject to income tax in the year that you withdraw it. Let’s use the below example to illustrate the point:

• Your Pension pot is worth £100,000
• You take a tax-free lump sum of £25,000
• This leaves you with £75,000 in your pot to be invested
• You take an income of £15,000 for the year
• Assuming you are a basic-rate taxpayer, £12,570 of that £15,000 is tax-free
• The remaining £2,430 is taxed at 20%, leaving you with £1,944
• In total, that leaves you with £14,514 (£12,570 + £1,944).

Is a drawdown Pension subject to Inheritance Tax?

In most cases, drawdown Pensions are free from Inheritance Tax as long as the money remains within a Pension or drawdown fund. And if you pass away before the age of 75, your beneficiary won’t have to pay income tax if they start accessing the funds within two years of us being notified of your .

Your beneficiary may have to pay tax if you are under the age of 75 when you pass and they’re paid the lump sum more than two years after the Pension provider is told of your death.

In this event, if it is paid to someone in an individual capacity, the lump sum will be taxed as Pension income on that individual at their marginal rate.

Can you draw down a final salary Pension?

Yes, if you have a final salary Pension yet to be accessed, it is possible to transfer that into a drawdown. This could offer you a greater level of flexibility if right for your needs. However, it’s important to remember that, by transferring your money into a drawdown to be invested, there is the possibility that the value of your pot could go down as well as up. A final salary Pension, on the other hand, provides a guaranteed income for life, so you need to weigh up the best decision for you and your situation.

Can I transfer my drawdown Pension to another provider?

Yes, if you wish to change provider for whatever reason then you can transfer your drawdown Pension. It’s your money, so it’s crucial that it’s sat with a provider you are happy with, and one that you feel is delivering the best value for you. Any transfer must be for the whole value of the existing assets and must be on a like-for-like basis, while there are typically two options for doing this:

• Your investments are sold before the transfer and your Pension is transferred as cash.
• Your Pension is transferred with your investments still in place. This is reliant on your new provider offering the same investments as your old one. It is also usually the more expensive and time-consuming option of the two. 

Are drawdown Pensions protected?

The Financial Services Compensation Scheme (FSCS) may be able to protect the money in your drawdown Pension under its investment cover. Bear in mind that the FSCS cannot protect you if your investments simply don’t work out. However, it may be able to offer compensation if your provider goes out of business or if you’ve lost money based on bad advice given to you by your adviser.

Is a drawdown Pension a good idea?

A drawdown Pension can be a practical and tax-efficient way of making your money do more. An investment’s growth is typically more effective towards the end of its time invested, as it has had the time to benefit from potential compound growth. With a Pension drawdown, you can take some money while still being invested to help reach your retirement goal.

But as with any investment, capital is at risk. Money left invested can go down as well as up so, to manage your risk, you should make sure your Pension is invested in line with your needs and risk appetite and leaving it invested for a longer time could potentially lead to a larger retirement pot. Investing in a globally diversified portfolio could help with your retirement goals as it means your eggs aren’t all in one basket and giving an investment time has been proven to help smooth out volatility in . Consult a financial adviser for professional expertise that is best suited to your unique circumstances. Past performance is not a guide to future performance. 

Pension drawdown could be a good idea if you want to take a Pension income now, while still leaving your Pension to potentially grow further. Remember, if you withdraw your Pension and leave it sitting in a cash ISA – not being used – you run the risk of your money losing value because of inflation.

Do you need a financial adviser for Pension drawdown?

Any decision around your Pension pot is a big one, one that could have a significant impact on your future as well as the future of your loved ones. There are considerations to be made on how tax efficiency works, how charges could apply and the status of the current markets. With all that to bear in mind, we would always recommend speaking to a financial adviser to decide if a drawdown Pension is right for . You can also speak with MoneyHelper for free and impartial money and pensions guidance. You can contact them on: 0800 011 3797.

We can help you to unlock the True Potential of your Pension, so please don’t hesitate to send us a message or call us on 0191 625 0350.