What is pension income drawdown?

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After taking up to 25% tax-free cash, the remainder stays in your pension pot to access how and when you want.

For example, you could take your tax-free lump sum and receive the rest as regular, taxable income or in smaller amounts when you need it.

This guide will explain how income drawdown works so that you can decide if it’s right for you.

How does pension income drawdown work?

Pension income drawdown, also known as flexible retirement income, is a way of accessing your defined contribution pension savings when you reach 55 (rising to 57 from April 2028).

You can normally take up to 25% of your pension pot as a tax-free lump sum and leave the rest invested or access as and when you want. This tax-free cash must be taken at the time you move your pension pot into income drawdown, not at a later date.

You can choose whether to move your pension pot into income drawdown all at once, or in stages. Leaving the remainder of your money invested provides the opportunity for growth. However, as with any investment, the value of your pension can go down as well as up, so any income you receive isn’t guaranteed.

It is worth noting the maximum tax-free limit for your pensions combined is normally £268,275, but this may be higher if you hold a protected allowance.

What are the pros and cons of pension income drawdown?

Income drawdown is not for everyone. It typically suits people willing to accept an element of investment risk in return for potentially higher income from their pension, or those seeking greater flexibility over their pension income and want to dip into their savings when they please.

As income drawdown carries a higher element of risk than other retirement options, it is important to research it thoroughly and seek professional retirement and pension advice.

When might pension income drawdown be a good option?

Income drawdown can be a useful if you’re reluctant to take all of your pension immediately. For example, you may decide to continue working part-time.

You’ll also need to accept the higher risk involved with leaving your pension savings invested in the stock market. As stock markets fluctuate, you could end up with less retirement income than you’d planned for. Because of the greater element of risk, income drawdown is more popular with those with a large pension fund or with other sources of retirement income such as alternative savings or investments.

How else can I take my pension aside from income drawdown?

There are numerous ways to access your pension savings aside from income drawdown. These include:

• Buy an annuity and receive your pension fund through a regular, guaranteed payments for a fixed term or the rest of your life. You can also request a lump sum payout.
• Take all or a portion of your pension savings as a lump sum, regardless of how much you have saved.
• Use a combination of all options including income drawdown.

It is important to understand the varying tax rules that apply when you access your pension, as they can have a significant impact on your savings. Also, always seek professional financial advice before choosing the options that best suit your needs.

FAQs on pension income drawdown

Will I pay income tax on pension income drawdown?

The first 25% of your pension pot is usually tax-free. You’ll need to access this at the outset. You can’t access any tax-free money after your pension savings have been moved into income drawdown.

You do not need to put your whole pot into income drawdown in one go. You can access part of your pension pot, taking 25% of this portion tax-free and placing the remaining 75% in drawdown. You can then take your remaining 25% tax free entitlement later on, when the remainder is placed into income drawdown. This can allow your overall tax free cash further time to grow.

After this, all income and subsequent drawdowns will be subject to income tax. You’ll pay this tax as earnings in the tax year you take it.

It’s important to note that if you make a larger withdrawal, it could push you into a higher tax band. In this case, it may be possible to reduce the amount of tax by spreading payments over several years or gradually moving your money into drawdown.

You should also be aware that if you take a lump sum instead of regular income, your provider may apply a temporary tax rate referred to as ‘emergency tax’.

From tax year 2024/25 and onwards, the former lifetime allowance charge placed on pension savings exceeding £1,073,100 is being replaced with the lump sum allowance and lump sum and death benefit allowance.

It's worth bearing in mind, the latest Budget saw inherited pensions – pension funds that are unused and death benefits payable from a pension – have been proposed to be added to the IHT limit under the latest reforms from April 2027 (subject to consultation).

Can I keep paying into my pension if I move into drawdown?

Yes, you can continue to pay into your pension if you move into drawdown, but there are some major tax penalties to be aware of.

If you’re planning to take your tax-free lump sum and continue to make further pension contributions, the following will apply:

• Pension recycling rules: These were introduced to stop people receiving additional tax relief on pension contributions where they have already benefitted from tax relief.
• Money Purchase Annual Allowance (MPAA): This is a restriction on the amount you can pay into your pension and still receive tax relief. It kicks in when you start to take drawdown income for the first time. The MPAA is £10,000 for the 2024/25 tax year. It was created to stop people avoiding tax on current earnings, or gain tax relief twice, by withdrawing pension savings and then paying them straight back in.

If you are thinking of reinvesting your tax-free lump sum into a pension, a financial adviser will help you decide if this is the best option for you.

Is pension income drawdown better than an annuity?

There is no one-size-fits-all answer, and the best pension option for you depends on many factors such as your financial situation and other sources of income you may have during your retirement.

As always, speak with a financial adviser to discuss the most suitable retirement option for you, or which combination of options and pension products are available to you.

How do I invest my savings with a pension income drawdown?

If you opt for income drawdown, you’ll have control over how your pension pot is invested.

Your provider will ask how you want your remaining savings invested when you move your money into income drawdown. You can:

• Choose your own investments that match your attitude to risk and your financial requirements.
• Choose pre-selected investments devised by your provider and linked to your retirement goals, also known as Investment Pathways.

Remember, all investments including those related to income drawdown can go up or down. Therefore, you’ll need to regularly review your investments to check they continue to meet your expectations.

I have pension income drawdown. Can I change my mind?

Yes, you can change your mind and use all or some of the money in your income drawdown pot to buy a guaranteed income, such as an annuity, or other retirement income products.

Before you decide, it’s wise to speak with a financial adviser who can explain which options are available, and which retirement products are best for you.

Are you considering pension income drawdown for your retirement?

If income drawdown is something you are considering in retirement, we’re here to talk you through the process. Our team of friendly and knowledgeable financial advisers will guide you through your options, help you manage the money you’ve invested, and provide the best personalised option for you. Request a call back today.