10m+
Customers helped
27,000
Advisers
1989
Est.

What is a drawdown pension? Retirement income explained

Updated 03 December 2020

6min read

Nick Green
Financial Journalist

If you have a defined contribution pension, there are a number of ways in which you can use it to fund your retirement. In the past, most people used their pot to buy an annuity (a guaranteed income for life) and this remains a popular option. However, pension drawdown rules allow for a more flexible – if riskier – form of income.

  1. What is pension drawdown?
  2. How does drawdown work?
  3. What are the advantages of drawdown?
  4. What are the disadvantages of drawdown?
  5. Which providers offer drawdown?
  6. Is drawdown right for me?
  7. Frequently asked questions about drawdown

What is pension drawdown?

Pension drawdown is a way to take a flexible income from your pension savings. Over your career, you will hopefully have built up pension savings in either workplace pensions or private ones. If these are defined contribution pensions (as opposed to defined benefit) then you will end up with one or more pension pots. You can use the money in your pension pot(s) to support you in retirement. There are several ways to access this money, and drawdown is one of them.

Drawdown allows you to make withdrawals of money from your pension pot. The withdrawals are classed as income (so are subject to tax). You can take as much or as little as you like, within the limits of your pension pot – once your savings are gone, they’re gone.

What is the difference between flexi-access drawdown and capped drawdown?

When people talk about 'drawdown' these days, they usually mean flexi-access drawdown. The term 'flexi-access' was originally added to distinguish it from something called 'capped drawdown', which is no longer available except to people who set it up before April 2015. If you have a capped drawdown scheme in place, it lets you take up to 150% of the income you could have received from an annuity, for as long as your fund lasts.

Flexi-access drawdown has no such cap, so you can take as much income as you like for as long as your fund lasts. Since this is now the only kind of drawdown that is available, it is usually referred to as just 'drawdown'. All mentions of drawdown here therefore refer to flexi-access drawdown, unless stated otherwise.

How does drawdown work?

When you set up a drawdown scheme, the money accumulated in your pension pot is moved into a new set of investments, called a fund. You will draw money out of this fund over the years to come, so the fund itself needs to be set up to try and make your pension savings last as long as possible.

Being invested in assets such as stocks & shares, your fund will rise and fall with the movements of the stock market. This can deliver strong growth, but can also put you at risk of losing money. The blend of investments in your drawdown fund can therefore be crucial – you want a mix of assets that can deliver steady growth over the long term, while being as resilient as possible in the face of stock market dips.

This can be a challenging decision to make, which is why it’s so important to seek independent financial advice when considering or choosing a drawdown scheme.

What are the advantages of drawdown?

The main upside of drawdown is that you can vary your income. If you need to spend more in a particular year you can increase the amount of money you take. On the other hand, if you have a low-spend year, you can reduce your income and lower your tax bill at the same time.

Another possible benefit of drawdown is that it has the potential to deliver a higher overall income than an annuity. However, the reverse can also be true – see ‘What are the disadvantages of drawdown?’

A significant benefit of drawdown is that you retain ownership of your pension pot (unlike with an annuity, where you surrender the pot). This means that your family can inherit any unspent pension pot when you die, free of tax. This is particularly advantageous for your beneficiaries if you happen to die sooner than expected.

What happens to drawdown when I die?

When setting up any pension or drawdown scheme, you must specify the person(s) who will receive any remaining benefits in the event of your death. Any person named in this way is a ‘nominated beneficiary’.

Your nominated beneficiaries will inherit your remaining drawdown fund tax-free if you die before the age of 75. If you die later than that, they will still inherit the fund but must pay income tax on the money they take from it (the tax will be charged at their marginal rate).  

What are the disadvantages of drawdown?

The main thing to remember about drawdown is that your pension pot is of a limited size. So unlike an annuity (which pays a guaranteed income for life), a drawdown scheme can run out of money.

Your pension pot can also lose value. The pot remains invested in the stock market, so if the market performs badly, it can shrink even if you don’t take any income. Also, taking money out during a period of low performance makes it much harder for the pot to grow again. Drawdown funds can therefore shrink much faster than expected if the market performs poorly. This makes it hard to judge how long they will last, or how much income you can safely take. It is perfectly possible for drawdown to under-perform annuities.

Finally, because of such risks, a drawdown scheme needs ongoing attention from you and/or your financial adviser – unlike an annuity, which takes care of itself once it’s set up.

How long will my pension last?

Predicting the lifespan of a pension in drawdown is hard to do, because the fund’s rate of growth will change. For example, you cannot say that a fund of £100,000 paying an income of £4,000 a year would last 25 years, because you need to factor in fund growth. If such a fund achieved a steady 4 per cent growth it would almost never run out, because it would earn nearly £4,000 in interest alone. However, in the real world growth is not steady, and any fund shrinkage – especially early on – can shorten the life of your pot.

Ask your financial adviser what level of income they recommend taking from your pot, and try not to exceed this too often. Also try not to make large withdrawals if performance is poor – so monitor your investments regularly.

Which providers offer drawdown?

Many of the UK’s largest pension providers offer drawdown, including:

  • Scottish Widows
  • Royal London
  • Prudential
  • Aviva
  • Standard Life

If your pension provider doesn’t offer drawdown, many will allow you to transfer your money to another pension scheme. You’ll need to check whether your current or new provider charges for this and if there are any other restrictions or rights you stand to lose before going ahead. Generally, you’ll also need to transfer to another UK pension scheme, or you’ll be taxed on the transfer (even if you don’t actually withdraw any money).

Is drawdown right for me?

Choosing to use drawdown should not be a quick decision. Whether or not it suits you will depend on many factors, including your overall finances, your retirement plans, your family situation, your attitude to risk, and the current economic circumstances too. For this reason, no-one should opt for drawdown without first discussing it with an independent financial adviser.

Your adviser will help you decide whether drawdown is best for you, and can also find the most suitable scheme for you from the whole of the market. You may even discuss using drawdown as part of a combined strategy that also includes an annuity, to give a balance of flexibility and security.

FAQs

What is the difference between drawdown and UFPLS?

One key difference is that with drawdown, you take your 25% tax-free allowance at the beginning. With UFPLS (uncrystallised funds pension lump sum), each amount you take is 25% tax free and 75% taxed. For example, if you withdraw £5,000 from your pension, you’d get £1,250 tax free and pay income tax on £3,750 of it.

An equally important difference is that your drawdown scheme will be invested with ‘decumulation’ in mind – that is, the investments will be designed to work best while you are drawing out money rather than depositing it. By contrast, if you leave your funds in your old pension pot, the investments are set up with ‘accumulation’ in mind, and thus are less likely to deliver the kind of performance you need during retirement. This is why in the long-term it’s usually better to use drawdown rather than UFPLS.

Does Nest offer drawdown?

You can set up a drawdown scheme if you have a Nest pension. Currently, Nest itself doesn’t offer drawdown, but it’s a fairly simple matter to transfer your Nest pension pot to a drawdown provider. You should seek advice from an IFA if you want to do this.

What does beneficiary drawdown mean?

Before 6 April 2015, you could only pass on a drawdown pension to a direct dependant (e.g. a child). Now, you can nominate a beneficiary (also called nominee or successor) for flexi-access drawdown of your pension when you die, even if they’re not related to you. If you die before the age of 75, your beneficiary will also receive your pension savings tax free.

What is phased drawdown?

If you’d like to slowly reduce your hours and supplement your income with pension drawdown, you can opt for phased flexi-access drawdown. From the age of 55, you can take chunks of your tax-free allowance to make it easier to transition into retirement.

Can I transfer from capped drawdown to flexi-access drawdown?

Some schemes will convert a capped drawdown to flexi-access drawdown automatically if the GAD (Government Actuary Department) limit has been reached (£40,000 for the 2020/21 tax year). You can also ask your scheme to switch you over or transfer your money to another scheme that offers flexi-access instead.

Find out more about your options for drawing your pension.

Let us match you to your
perfect financial adviser

About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.