Understanding Pension drawdown: six things you need to know

Pension drawdown has become more popular since the 2015 “pension freedoms” were put in place, as you are no longer forced to buy an annuity, opening up more options and flexibility.

As you have new options when you come to take your pension, this could be a good time to review your financial plans.

Luckily, the pensions freedoms changes could mean you now have more flexible options. Through careful pension planning you might be able to implement an updated approach that factors in the current situation and your future retirement goals.

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But what exactly is drawdown, and what impact might it have? Here’s six things we think you need to know.

1.Drawdown is a way of keeping your pension invested

When paying into a pension over your working life, your pot is invested on your behalf with the aim of boosting its overall value.

In short, pension drawdown is a flexible way of continuing this arrangement going into retirement. Your pension remains invested, and you either choose to take a regular income from it or make ad hoc withdrawals as and when needed.

2. Investment and risk

As with most investments, the value of your pension could fall, as well as rise. You must make sure your fund is exposed to a level of risk you are comfortable with, whilst keeping track of its performance. Your investment strategy will need to take into account your plans for future withdrawals, and how long you would like your fund to last.

3. Keeping a careful eye on the amount you are withdrawing

Whether you go for annuity or drawdown, only 25% of your pension is tax free cash. The rest will be taxed as income and potentially subject to income tax.

Another important point is that taking too much too quickly from your pension, could exhaust your pension pot completely or could lead to it running out sooner than you would like.

If you need this money to last you throughout retirement, a careful plan will be required as well as a regular review of your funds.

person standing looking at hot air balloons

4. Planning for drawdown several years before retirement

When you get closer to your planned retirement date, you should be paying increasingly close attention to your pension.

If you are in your pension provider’s default fund and have a life-styling strategy, they might automatically start to reduce the level of risk it is exposed to, in preparation for you coming to access it.

However, if you intend to remain invested through drawdown, you might not want to lower your risk level in the run-up to retiring. Either way, you need to find out and make plans for the future.

5. You don’t have to commit your full pension pot in drawdown (or stay invested forever)

The “pension freedoms” are designed to do what they say on the tin – to give you freedom. You can shape your retirement plans however you like.

So, if you don’t want to remain fully invested, you could arrange an annuity with some of your pension funds.

This would mean that you might spend some of your fund on securing a guaranteed income (through annuity), whilst at the same time keeping some fund invested that might benefit from any future investment growth.

As you get older, you might also wish to convert your remaining drawdown into a lifetime annuity. so you have the certainty of having secured an income that's payable for the rest of your retirement.

Any investment has to be viewed in years and not months, so you shouldn’t wait until retirement to look at drawdown, if this is the route you intend to go down.

6. Making the most of Death Benefits

Your pension fund can pass on lump sum benefits on your death to beneficiaries, typically to family members. It might also pass on benefits on the subsequent death of a dependant or nominee.

You need to consider how you intend to use your drawdown fund, perhaps for income and tax free cash, but taking into account the potential to run out of income versus the benefit of being able to pass monies on to your loved ones.

With all the above in mind, our recommendation is that you speak to an expert so that you can build a suitable plan that works for you.

What about the pension freedoms?

Before the pension freedoms, you would have had to use most of your pension to arrange an income. So if you were to retire just after a market fall, you’d have probably had to accept a reduced level of income for the rest of your life. Or even have to delay retiring, in the hope your pot would grow again. Neither would be ideal choices.

With the pension freedoms, from the age of 55 you have the flexibility to decide when and how to take your pension. This means you could keep some or all of it invested when you retire, to give it the chance to grow stronger over the long-term. A market fall, just before you retire, would have a short-term impact, but it might not need to completely change your plans.

Gareth Smith, Skipton Retirement Solutions Manager

For retirement solutions such as drawdown, your capital is at risk, so you may get back less than you originally invested. The value of investments and the income from them may fall as well as rise. If you take too much income too quickly, your fund could become depleted or run out altogether. Annuity rates depend on your individual circumstances such as age, health and lifestyle factors, as well as the rates available at the time of purchase.

A conventional annuity has no cash-in value to you as an individual, and once selected, the options chosen cannot usually be changed.

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