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Income drawdown helps your pension fund to keep growing

The right income drawdown pension can help you stay invested after retirement to get the best value possible from your savings pot.

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Pensions are long term investments. You may get back less than you originally paid in because your capital is not guaranteed and charges may apply.
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Salman Haqqi
Editor
Lucinda O'Brien
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Sara Benwell
Last updated
February 22nd, 2024
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What is a pension drawdown?

Income drawdown is one of the ways you can access your pension savings to fund your retirement.

Thanks to rule changes in 2015, you can now use your pension fund however you like after you reach the age of 55 (rising to 57 from 2028).

Income drawdownÌýis one of theÌýmain options available for taking your pension. ItÌýallows you to make regular withdrawals or take lump sumsÌýfrom your savings so you can fund specific purchases or day-to-day living expenses. TheÌýrest of your cashÌýstays invested in your pension pot, meaning itÌýcan continue to grow tax-free.

The money you draw from your fund in any given year counts as income – so you’ll pay tax on it, just like wages earned from a job. However,Ìý25% of your pension is available free of income tax, so you can either take this as a lump sum up front and pay standard income tax on the rest, or take 25% of each withdrawal tax-free throughout retirement.

You can read our full guide onÌýhow to withdraw a pensionÌý³ó±ð°ù±ð.

Income drawdowns in 2023/2024[1]
278,977

What are the pros and cons of an income drawdown pension?

Pros

Ability to vary your income depending on your needs
The money you’re not using is invested, so it continues to grow
Investment growth is tax free

Cons

Large early withdrawals may mean you don’t have enough money later, so you need to manage funds carefully
Flexibility typically leads to more administration costs
Investment and fund performances affect your income, and future returns are not guaranteed
“Income drawdown pensions can give you flexibility and control over your retirement fund, with withdrawals suited to your needs. However, this freedom comes with the responsibility of financial management as you’ll need to ensure you have enough money throughout retirement.â€
Author image
Lucinda O'Brien
Savings expert

How to choose a drawdown pension

Here are the four key things to consider when choosing an income drawdown provider:

Who will manage the investments?

If you have a lot of investment knowledge and time to keep on top of your portfolio, you might consider a Self-Invested Personal Pension (SIPP). This means you’ll make all the investment choices on your own. However, for most people it makes more sense to leave those decisions in the hands of the professionals. You can do this by choosing a provider that offers a default, ready-made portfolios, or that will invest for you after you answer some questions about your risk attitude and goals.

How much will it cost?

High charges can wipe thousands off your portfolio, meaning the difference between a comfortable retirement and one where you struggle for money. Key things to look for are platform fees, set-up costs, annual administration charges, and transaction costs or commission when trading funds and shares.

Investment options

If you decide to get a SIPP, consider which provider offers the best range of investments. Consider what asset classes you can access, including things like infrastructure and private equity. If you’re looking for a managed portfolio, check to see whether there are options outside the default, and whether options are tailored to your risk and goals.

Investment pathways

To make it easier to find the right drawdown product, the government has created four common retirement pathways; number one - I have no plans to touch my money in the next five years, number two - I plan to use my money to set up a guaranteed income within the next five years, number three – I plan to start taking money as a long-term income within the next five years and number four - I plan to take out all of my money within the next five years. Drawdown pensions allow you to take an income without buying an annuity. You should also consider any rules the provider has about how often you can make withdrawals, and how quick and easy the process is.

Which are the best drawdown pensions?

The right income drawdown pension for you depends on how likely you are to take your money and what kind of access you want. Different pension providers have a range of flexible drawdown options on offer, so it’s important to compare deals.Ìý

Check with your provider, but your pension drawdown options should include:

  • Taking some as an income and leaving the rest invested (you can choose the amount you take and leave)

  • Withdrawing up to 25% tax free from your pension, then taking the rest as an income

You might also be allowed to withdrawÌýup to 25% tax freeÌýfrom your pension, then splitting the rest between an annuity and income drawdown.

"Decide what you want to do with your money first, then find the best plan for you.â€

If you choose to take a large income drawdown from your pension fund from the start of your retirement, you might run out of money later in life. A drawdown calculator may be helpful for your calculations.

Another option is to delay using your pension, which means it could carry on growing, tax-free. This might be an option if you've already got enough money to live off, for instance in other savings such as ISAs. You could carry on making pension contributions and getting tax relief on them.

You may also want to use a mixture of pensions income and ISA savings each year to keep the tax you pay as low as possible. An independent financial adviser (IFA) can help you to structure all your retirement income so it is tax-efficient.

There's lots of choice in terms of what you can do with your pension when you reach the age of 55 (rising to 57 in 2028) or retire. You can even mix and match the different choices. But remember thatÌýnot every pension provider will offer all the options, so you'll have to check carefully.

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Pensions are long term investments. You may get back less than you originally paid in because your capital is not guaranteed and charges may apply.

Income drawdown vs an annuity

Income drawdown

Income drawdown

This lets you pull as much or as little as you like from your pension fund in any given year. But taking too much, too soon could leave you with nothing at all later in life. Also, making big withdrawals could push you into a higher tax bracket, so you should only take what you need.

Your money stays invested, so the value of your savings can continue to grow. However, if the stock market falls and you need cash, you may crystallise those losses. If there's anything left in the fund after you die, this can be passed on to relatives free of inheritance tax.

Annuity

Annuity

An annuity gives you a guaranteed income for life in exchange for a lump sum. How much you get depends on annuity rates at the time you take one out, and sadly you can't change your mind later on. Once you're signed up, you'll get the same amount every year until you die, which makes it easier to plan and budget, but your pot won’t continue to grow. You can even buy annuities that rise in line with inflation. Annuities can't usually be passed on after death, although you can choose one with spousal benefits.

Income drawdown vs an annuity

Income drawdown

Income drawdown

This lets you pull as much or as little as you like from your pension fund in any given year. But taking too much, too soon could leave you with nothing at all later in life. Also, making big withdrawals could push you into a higher tax bracket, so you should only take what you need.

Your money stays invested, so the value of your savings can continue to grow. However, if the stock market falls and you need cash, you may crystallise those losses. If there's anything left in the fund after you die, this can be passed on to relatives free of inheritance tax.

Annuity

Annuity

An annuity gives you a guaranteed income for life in exchange for a lump sum. How much you get depends on annuity rates at the time you take one out, and sadly you can't change your mind later on. Once you're signed up, you'll get the same amount every year until you die, which makes it easier to plan and budget, but your pot won’t continue to grow. You can even buy annuities that rise in line with inflation. Annuities can't usually be passed on after death, although you can choose one with spousal benefits.

How drawdown pensions are taxed

You can choose to take the initialÌý25% of your pension tax free, but after that, any money withdrawn is considered an income and taxed in the same way as wages from a job. If you forgo the tax-free lump sum, 25% of all withdrawals are free of income tax, but you pay tax on the rest.

The amount you can draw down tax free was capped atÌý£268,275 from April 6, 2023 - unless your current pension provider has specific protections in place.

The income tax rules in England, Wales, and Northern Ireland say the first £12,570 is tax-free (unless you have income from elsewhere). You then pay:

  • 20% tax on everything between £12,571 and £50,270

  • 40% tax on anything between £50,271 and £125,140

  • 45% tax on anything above £125,140Ìý

Your personal allowance is smaller if you earn over £100,000, disappearing entirely if your taxable income is over £125,140.

You could use an income drawdown calculator or even a pension drawdown tax calculator to help you work out how much tax you'll pay if you take money out.

You can read our full guide toÌýhow your pension is taxed when you retire here.

Taking a lump sum in a single year could push you into a higher tax bracket.â€

What tax you pay on income drawdown
How much tax you'll pay on your pensions withdrawals in any given year.

What happens to a drawdown pension if you die?

Income drawdowns have a key advantage over annuities:ÌýÌýif you don't spend all your money, they can beÌýpassed on free of inheritance tax.

You can also leave a drawdown pensionÌýto anyone you choose. They don't need to be a spouse or dependent. Your pension fund will ask you who should get the money after you die, and you can change this whenever you want. Make sure you fill in the form stating who you want the beneficiary to be, or the administrators will have to decide where they want the money to go.

While drawdown pensions can be left inheritance tax free,Ìýthe beneficiary may have to pay income taxÌýon the money depending on how old you are when you die.

The rules are:

  • If you die before you're 75, you can make arrangements for a drawdown pension to be passed on to a nominated person, free of income tax. It can either be taken as a lump sum or as a regular income.

  • If you're over 75 when you die, you can still make arrangements for it to be passed on to a nominated person, but they’ll have to pay income tax on the money.

It'll be taxed according to their income. If you know what their income is, you can use a drawdown pension calculator to work out what they'd get.

Income drawdown pensions FAQs

Is there a limit to how much I can take as an income?

Most income drawdown pensions let you take what you want, but capped income drawdown pensions restrict how much you can take each year. However, you need to make sure your money lasts until you die.

Does my pension company have to offer me income drawdown?

No, but if it is something you want then you couldÌýtransfer your pension fundÌýto another company that does offer income drawdown.

Am I taxed on income drawdown?

Yes, but how much will depend on your income tax rate. You can find out more about pension tax here.

Is a drawdown pension a good idea?

An income drawdown is best suited for those who want to leave their pension fund invested in the stock market so that it has a reasonable chance of investment growth. You also need to manage your funds to ensure that you don’t run out of money. If you want the security of a guaranteed income for life, you may be better off with an annuity.

What is flexible income drawdown?

This is when you can change the amount you take as income each time rather than being tied to a specific amount. You can even time your withdrawals depending on what the investment market is doing and how your investments perform.

What happens to your private pension when you die?

What happens to a private (or workplace defined contribution) pension when you die depends on two things: Your age and whether you've started taking money out already. Money in a drawdown pension is free of inheritance tax, but depending on the circumstances, the beneficiary may have to pay income tax on it.

  • If you're under 75 and haven't started drawing on the money, the pension can be passed on - income tax free - for the beneficiary to use themselves. Beneficiaries must be paid the money within two years after the pension provider is told of your death.

  • If you're under 75 but have started drawing on your pension, then any money you have taken out already will form part of your estate - so could be included in inheritance tax calculations. The money left in your pension fund will be passed on, free of inheritance and income tax, for your beneficiary to use as a pension.

  • If you're over 75, any money left in your fund will still be free from inheritance tax, but the beneficiary will pay income tax on it. If there's a lot of cash left in your pension, this could push them into a higher tax bracket.

  • If you've converted your private pension into an annuity, it is linked to your life - so payments usually end when you die. There are some exceptions to this, though - including joint-life, value-protected and guaranteed-term policies - so it's worth considering whether you want these benefits before choosing a provider.

In depth pension guides

Find out more about your options and how income drawdown pension work with our in depth guides
How to manage your pension fund
How to manage your pension fund
How is your pension taxed when you retire?
How is your pension taxed when you retire?
Can you transfer your pension?
Can you transfer your pension?
Find more guides here

About the author

Author imageSalman Haqqi
Salman Haqqi
Salman Haqqi spent over a decade as a journalist reporting in several countries around the world. Now as a personal finance expert, he helps people make informed financial decisions.

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References

1. : FCA data