When it comes to drawing your pension, there is now far more flexibility than there has ever been before.
You might choose to take an income from the age of 55 (57 after 2028) or defer claiming it until later with the aim that your payments will be higher. You could also cash in the entire pot or buy an annuity that gives you a guaranteed income for life.
However, the most popular option is to draw out some of your fund while continuing to invest the rest â otherwise known as a pension drawdown.
How does pension drawdown work?
A drawdown means you can take as much or as little from your pension as you wish, which is why it’s sometimes also referred to as a flexi-access drawdown. This hasn’t always been the case though. Before 6th April 2015, income from a drawdown was capped and reviewed every three years. While some people continue to use an existing capped drawdown, many have now moved to flexi-access while new customers are automatically enrolled onto this.
Your existing provider may allow you to draw down your pension, or you might have to move to another â either way, it’s advised to shop around to make sure you are getting the most competitive deal. If you aren’t sure, always seek professional advice.
How much can I withdraw from my pension?
As with other defined contribution pensions, you can take up to 25% of your fund as a tax-free lump sum â anything above that is liable for tax. Just like employment, your provider will deduct the tax you owe on a PAYE (pay as you earn) basis.
However, if you’re self-employed, or you have income from other sources, you’ll probably need to submit a self-assessment tax return with details of all your earnings. For those with pension savings above Â£1,073,100 (the current lifetime allowance) further tax charges may apply.
Many people have a retirement goal, such as going on the holiday of a lifetime, paying off their mortgage or helping their children to get on the property ladder.
But bear in mind that you don’t have to take the entire 25% just because you can. Assuming you’re on track to lead a long and healthy life, your pension should last for as long as possible and not run out. Not only that but the more you leave in the pot, the more likely your investments are to grow. If you have multiple smaller pots from various employers, usually of Â£10,000 or less, you may choose to cash one or more of them in and leave your other investments, or consolidate them into a single drawdown product.
Take stock: find a fund that works for you
The good thing about a drawdown is that it gives you an opportunity to reconsider your investments. Your workplace pension might have been invested into a default fund â however, you may now want more say in the type of fund you have. Depending on your priorities and appetite for risk, you might choose higher or lower growth funds, or ones which a more ethical or socially-responsible.
Like any type of investment, the money in your pension could go up or down depending on the fund’s performance. This is why it’s important to speak to a pension advisor who’ll talk you through your options and help you choose the most suitable fund for your circumstances.
What happens to a pension drawdown after death?
The advantage of a drawdown is that, unlike most annuities, you can nominate a beneficiary who could either claim the remainder of the pension as a lump sum, or draw an income from it and continue to invest the rest, just as you have done. Tax rules apply if the lump sum isn’t paid within two years of death.
The amount of tax your beneficiary pays depends on whether you die before or after the age of 75. If it’s the former then they won’t need to pay any income tax â however, they may have to pay lifetime allowance tax if it exceeds the government’s current limit.
If you die after the age of 75, your beneficiary might have to pay income tax but not lifetime allowance tax.
Sadly, you may be diagnosed with a terminal illness at any age which throws your retirement plans off-course. If you’re over 55 but under 75, your beneficiary can receive an income from your drawdown as outlined above. You could also draw down more than you’d planned to enjoy spending your well-earned money during the time you have left, though this will be taxed if you exceed the 25% lump sum.
People who’ve been given less than a year to live may be able to liquidate their full pension as a tax-free lump sum, depending on the terms of their plan.
Is pension drawdown right for me?
While a drawdown offers plenty of benefits, it’s not right for everyone. As mentioned above, it all depends on your attitude to risk since your investments can go down as well as up and there’s a possibility that your pension will run out when you reach old age.
If you’re more cautious, you might consider buying an annuity â an insurance policy â which provides an income for life based on the guaranteed annual growth rate (GAR). You could even buy an annuity using some of the money you take from a drawdown in order to reduce the risk of your investments.
While an annuity provides security, it is far less flexible than a drawdown. It’s not normally possible to surrender your annuity (and if it is, you’re likely to have to pay expensive fees). However, if you have certain medical conditions, you may be entitled to an enhanced annuity with higher payments based on your life expectancy being lower.
Finally, remember that unlike a drawdown, a single annuity stops paying out at death, so your spouse won’t receive anything from the pension pot you’ve built up. However, joint life annuities are available, or you could opt to include a guaranteed income for a partner or dependant after you die.
To learn more, read our guide: Pension Annuity vs Drawdown: Which Option Should I Choose?
For further support and to talk it through with a professional, book a call with a pension advisor here at Almond Financial.
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Tax treatment varies according to individual circumstances and is subject to change.
Transferring out of a Final Salary scheme is unlikely to be in the best interests of most people.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.