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What is pension drawdown?

pensions & retirement

Pension drawdown explained

Learn more about how pension drawdown works once you enter retirement.

If you are an ii customer looking to enter drawdown, view our ii SIPP drawdown page.

What is pension drawdown?

Pension drawdown is a flexible way of taking money out of your pension once you turn 55 (57 from 2028). 

It can be considered an alternative to an annuity, which is less flexible but guarantees a fixed income.

With drawdown, your pension stays invested. The benefit is that your pot could see investment growth and higher future returns while you control how much you take from your pension. On the other hand, your pension value could fall if share prices drop.

How pension drawdown works

In drawdown, you are in control of your income. You can choose to make regular withdrawals, dip into your pot whenever you need to, or even take out the whole pension in one go. 

You can also withdraw up to 25% of your pension as a tax-free lump sum. The rest of your pension withdrawals will be taxed as income at the marginal rate. 

- Capped drawdown

If you went into drawdown before the wide-ranging pension reforms on 5 April 2015 and have not converted to a flexi-access drawdown, then you will be in capped drawdown.

This means you are subject to a limit on the maximum amount you can take as income from your pension pot.

This capped drawdown limit, set by the Government Actuary’s Department (GAD), is roughly 150% of the annual income that a basic annuity would give you. The limit is reviewed every three years, and then annually after you turn 75.

You can convert from capped drawdown into flexi-access drawdown. However, you will lose the benefit of a standard annual contribution allowance (up to £40,000), and will be subject to the Money Purchase Annual Allowance (MPAA) of £4,000.

- Flexi-access drawdown

Flexi-access drawdown replaced flexible drawdown in April 2015 and since then has been available on all new drawdown products.

Flexi-access allows you to withdraw you pension savings whenever you need to while keeping the rest of your pot invested.

Drawdown pros and cons

Pros:

  • Your money could continue to increase in value while invested
  • You take whatever level of income you need, when you need it
  • You can manage your annual tax liability
  • Your pension can be passed on in death, normally free from inheritance tax

Cons:

  • You could run out of money
  • Your pension value could fall if share prices fall

How much tax will you pay in drawdown?

The first 25% of your pension pot can be taken tax-free. This can be as a lump sum or smaller withdrawals. The rest of your pension will be subject to normal income tax rates:

The first £12,500 is tax-free. 

  • 20% tax on the next £37,500 above this.
  • 40% tax on everything above £50,000 (£12,500 + £37,500) 
  • 45% tax on everything above £150,000.

These figures apply to income tax in England, Wales and Northern Ireland in the 2020/21 tax year. Income taxes in Scotland are different.

What is the lifetime allowance?

The lifetime allowance is the limit on the amount you can withdraw from your pension without extra tax charges. The allowance for the 2020/21 tax year is £1,073,100. 

Any savings above this limit will be subject to tax at 55% if it is taken as a lump sum or 25% if taken as income (plus this will also be subject to income tax when paid).

Tax relief and the Money Purchase Annual Allowance (MPAA)

After you start taking money from your pension, you are still allowed to make contributions, but the maximum amount you can pay in and claim tax relief on reduces from up to £40,000 to £4,000. 

This is known as the Money Purchase Annual Allowance and is only triggered when you start taking flexible pension payments.

Month 1 tax

When you start taking income from your pension, your provider will give you a tax code. If they do not, you may be charged a ‘Month 1’ tax, or an emergency tax, which can be quite high.

You will be able to claim this money back from HMRC directly – or, if taking regular income, this will correct itself once HMRC provide an up-to-date tax code.

What happens to your pension drawdown plan when you die?

In the past, pensions used to be taxed 55% before being passed on to your beneficiaries. Thankfully, this has been reformed.

Under the age of 75

If you die under the age of 75, there is zero tax to pay on your remaining pension which can be taken out as income or as a lump sum.

Over the age of 75

If you die over the age of 75, your beneficiaries will pay tax at their marginal rate of income tax, whether they chose to take the pension as income or as a lump sum.

Recent reform allows you to leave your pension to anybody you choose. It is important that you complete your pension provider’s ‘expression of wish’ form to note who you would like to inherit your pension.

Pension drawdown FAQs

Normal pension contributions are capped at £40,000 a year (or 100% of your gross earnings – whichever is smaller). Once you take your first taxable payment in flexi-access drawdown, this cap reduces to £4,000 (known as the Money Purchase Annual Allowance or MPAA).

This reduction does not apply to existing capped drawdown plans, where the annual contribution limit remains up to £40,000 or 100% of gross earnings (whichever is smaller).

Annuities

An annuity can be bought with some or all your pension pot. You will receive a guaranteed fixed income for life or for a set period. Find out more about drawdowns versus annuities.

One-off lump sums

Most pension providers will allow you to take your pension without opening a drawdown plan. The technical term for this is ‘uncrystallised funds pension lump sums’ (UFPLS).

The first 25% will be tax-free, and you can choose whether to take the other 75% as a single lump sum or by taking regular ad-hoc withdrawals. These will be subject to income tax.

Taking no income

You do not have to access your pension. You are free to leave your pension pot invested where it will continue to grow, tax-free. This means you will potentially have a larger sum to access when you are older or wish to pass on as inheritance.
 

Get more from an ii SIPP

We don’t believe in charging a percentage fee that goes up as your investments grow.

Our award winning SIPP gives you fixed, transparent pricing, with no percentage-based fees. So you can watch your portfolio grow while your costs stay the same.

Open a SIPP and pay no SIPP fee for six months. Following the offer period, the ii SIPP fee is only £10 a month. Terms apply

The ii SIPP is aimed at clients who have sufficient knowledge and experience of investing to make their own investment decisions and want to actively manage their investments. A SIPP is not suitable for every investor. Other types of pensions may be more appropriate. The value of investments made within a SIPP can fall as well as rise and you may end up with a fund at retirement that’s worth less than you invested. You can normally only access the money from age 55 (age 57 from 2028). Prior to making any decision about the suitability of a SIPP, or transferring any existing pension plan(s) into a SIPP we recommend that you seek the advice of a suitably qualified financial adviser. Please note the tax treatment of these products depends on the individual circumstances of each customer and may be subject to change in future.