SIPP: Income drawdown
Pension income drawdown allows you to choose how and when you take money from your pension pot.
What is drawdown?
Income drawdown is a way of funding your retirement. It allows you to take a lump sum (usually up to 25%) out of your pension pot, while the remaining funds are invested in a Flexible Investment Plan designed to provide you with an income. Because most of your pension pot is still invested, it could continue to grow in value. Whether you want to take your full tax-free allowance in one go or not will determine your next steps.
How to move your pension into drawdown
Income drawdown allows you to be flexible, and take control of how your pension income is managed. You can withdraw up to 25% of your SIPP tax-free, whilst keeping the rest invested by moving your SIPP into drawdown.
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Pension Drawdown Rules
- how does pension drawdown work?
SIPP drawdown rules
You can begin to drawdown your pension from age 55 (57 from 2028). Whatever percentage you choose to withdraw as a tax-free sum, the rest may be withdrawn later as taxable income.
Drawdown options
- If you want to take your full tax-free lump sum (25%) in one go, you can move your full SIPP into Flexi-Access Drawdown (FAD), where it will remain invested.
- If you want to take only a portion of your tax-free allowance at one time, you can move part of your SIPP into FAD (e.g. to receive £10,000 tax-free, you would move £40,000 to FAD). You can then receive further tax-free payments later.
- To take a lump sum without moving your SIPP into FAD, you can take an uncrystallised fund pension lump sum (UFPLS), 25% of which is tax-free and 75% subject to income tax (e.g. of £10,000, £2,500 will be tax-free).
How much income can I take from my pension pot?
One of the advantages of the SIPP is that you can choose how much income you want to withdraw, after you have taken your tax-free lump sum and moved your SIPP into income drawdown. You can choose to make regular withdrawals or take larger sums as and when you need them. You can also buy an annuity, which will provide you with an income in retirement. However, you must be aware that any income you take, after your tax-free lump sum, will be subject to income tax, as with any other pension. This may include higher-rate tax if you go over the threshold in the tax year.
How is drawdown income taxed?
Tax on SIPP drawdown operates the same way as other forms of income tax. After you have taken your tax-free lump sum, any subsequent withdrawals are subject to income tax. This tax year, the rules are:
- If you have no income from any other sources, the first £12,500 is tax-free.
- 20% on the next £37,500 above this.
- 40% on everything above £50,000 (£12,500 + £37,500)
- 45% on everything above £150,000.
Lifetime allowance
The lifetime allowance is the limit you can save in your SIPP over your lifetime. This tax year, the allowance has been raised to £1.055million. Any savings above this limit will be subject to tax at 25% plus income tax if it is used as income, or 55% if it is taken as a lump sum.
Tax relief and the money purchase annual allowance
After you start taking money from your SIPP, you are still allowed to make contributions to your pension, but the amount you can pay in and claim tax relief on reduces. This is known as the Money Purchase Annual Allowance.
Month 1 tax
When you begin to take income from your SIPP, your pension providers should give you a tax code. If they fail to do so, you may be charged a "month 1" tax, also known as emergency tax. This means your personal allowance, basic tax allowance and higher rate tax band will all decrease to one twelfth of their normal level. Often, you will be able to claim this money back from HMRC but it can significantly decrease your income in the first month. The overpayment should be corrected without further action within a few weeks once a correct code is generated and passed to your pension scheme.
What happens if you die?
If the pension-holder dies before the age of 75, the fund can be passed, free from tax, to any beneficiary as a lump sum or an income drawdown pension. If the funds are uncrystallised, they can also be passed on as an annuity. If the pension-holder is over 75, then the fund will be passed on at the marginal tax rate, or paid into a trust as a lump sum, minus a 45% tax charge.
What are the pros and cons of income drawdown?
Benefits:
✔ Flexibility: Unlike an annuity, you can change the amount you receive to suit your circumstances.
✔ Estate Planning: Pass on any remaining pension fund to your beneficiaries without inheritance tax.
✔ Increased Control: You decide the returns you want to target, the risks you're willing to accept and the investments you want to pick
✔ Tax Efficiency: Managing the amount of tax free sum you receive, and choosing when to go into drawdown, can help to minimise your tax exposure.
Risks:
✔ Investment Issues: Your pension pot remains invested after it is placed into income drawdown. Therefore its value could reduce if the market dips.
✔ Tax Implications: After you have taken your first income from your SIPP, the annual contribution allowance drops to £4,000. This prevents you from topping up your pension pot with larger sums even if you have the funds available.
✔ Management Issues: The value of your pension pot will be affected by the success of your investments, and the charges you pay. This means you must manage your SIPP carefully, or pay for help from a suitable financial adviser.
How can Pension Wise help?
Everyone with a Defined Contribution pension scheme is entitled to access free, impartial guidance on their pension options, including a face-to-face or telephone appointment, provided by Pension Wise, a guidance service backed by Government.
Drawdown alternatives
Annuities:
An annuity product which you can buy with some or all of your pension pot. It will provide you with a fixed income for life or for a set period.
Lump Sums or UFPLs:
Most pensions will give you the option of taking some or all of your pot as a lump sum. Normally you will have to pay income tax on anything above the first 25% of the total value of your pension pot.
No income option:
You may decide to leave your pension pot untouched on retirement. It will then continue to grow, tax-free, meaning that you will potentially have more income if you decide to access it at a future date.
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