You can take regular income payments from your pension pot without having to purchase an annuity by simply making regular income withdrawals. This is called pension drawdown.
Pension drawdown has been available since 1995 but historically it was only thought suitable for those with funds above a certain size for instance above £ 100,000. With the new freedoms drawdown has become more popular and almost any size of pension pot should be able to benefit from drawdown. However some pension companies may have minimum funds sizes for their drawdown policies.
Flexi access drawdown
All new drawdown policies are called ‘flexi-access drawdown’. There are no income limits so you can decide how much income you want to take. You can withdraw up to 100% of the fund as an income payment but you will be taxed at your marginal rate on any income taken.
How drawdown works in practice
Your pension pot remains invested in a pension plan and you can take regular income withdrawals. You can change the amount of income you take each year but don’t forget you pay tax on the full amount of income taken.
The most important thing to remember is that unlike an annuity, your income is not guaranteed and if you take too much income in the early years or if the fund does not increase in value as planned, you could end up with a lower income or even run out of money entirely. The graphics below show how drawdown may play out over the course of your retirement depending on investment returns.
If your pension fund increases in value after taking income drawdown payments you can increase your payments in the future.
If your pension fund decreases in value after taking income drawdown payments you may have to reduce your income payments.
Advantages and disadvantages
What happens after your death?
You can nominate one or more beneficiaries who will receive your remaining pension pot after you die. The table summarises the death benefit options and the tax treatment:
Watch out for
There is a lot to watch out for but by far the two most important things to keep an eagle eye on are the amount of income you take out and where your drawdown is invested.
These two things are intricately linked because of the sequence of return risks. Investing when you are taking income withdrawals is different to investing without taking income and this is because if the returns are low or negative in the early years you will erode your capital fast and it will be hard to recover from early losses.
When you take income from a flexi-access drawdown it will be a trigger event for the Money Purchase Annual Allowance (MPAA).
Although drawdown may seem easy to understand the risks are much harder to understand, especially if compared to the guaranteed income from an annuity. We consider these risks when we look at the important questions in the next section.