Pension Drawdown

Pension drawdown is the process of taking money out of your pension, i.e. drawing down from it, without purchasing an annuity. A pension should really only be used in a person’s retirement, but they are accessible from age 55 onwards, so can provide an emergency fund of sorts if required.

There are many reasons why someone would go into drawdown:

  • Deferring an annuity purchase, thus avoiding being locked into low annuity rates which may apply at the time of retirement;
  • Enabling the policy holder to buy an annuity when it best suits them and hopefully when annuity rates are more favourable or provides an opportunity to avoid purchasing an annuity altogether where appropriate;
  • Enabling investors to retain control over their pension investments and allows them to continue to be invested in the markets, and hopefully make gains on their existing money; and
  • Allowing income to be varied within allowable limits thus giving valuable flexibility, which is useful for tax planning or where other income may have changed.

There are two different types of drawdown contract you can own – capped drawdown and flexi-access drawdown.

Capped drawdown allows you to withdraw income, within limits, from your pension fund without purchasing a lifetime annuity. This was the traditional method of drawdown but has been superceded by flexi-access drawdown. No new capped drawdown arrangements can now be created, however it is still possible to transfer from one capped arrangement to another and, in some cases, for additional pension funds to be added to the capped drawdown plan.

The maximum amount of income that can be drawn is 150% of a comparable lifetime annuity based on tables published by the Government Actuary’s Department. It is not however necessary for any income to be taken. Any amount of income from zero income through to the 150% maximum can be selected. The plan and maximum income will be reviewed every three years up to the anniversary of entering drawdown until the 75th birthday and annually thereafter.

Flexi-access drawdown is very similar to capped drawdown but does not have as many limits with regards the income which can be withdrawn from your pension fund; it is flexible with regards the money which can be taken out.

For flexi-access drawdown, you can choose how much income you want to withdraw without reference to any rates or limits other than the size of your pension fund. If you or your spouse is relatively young, a secured pension (lifetime annuity or scheme pension) would be less attractive due to the lower mortality factor and, in addition, there is a longer timescale to take advantage of the potential investment rewards and risks of a drawdown pension. However, the levels of income provided may not be sustainable, so in other words, your pension fund may run out.

Irrespective of what drawdown contract you have, taking withdrawals may erode the capital value of the fund, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income if/when an annuity is eventually purchased, or no fund at all if fully withdrawn.

Most drawdown contracts allow for the first 25% of a withdrawal to be taken tax-free; everything thereafter is fully taxable at source.

Past performance is not a reliable indicator of future results