Income drawdown explained
Last updated 16 March 2016
Drawdown is a flexible way of using your pension savings but it is risky if you are relying on it for income to pay your bills.
If you belong to the type of workplace pension scheme where you build up your own pot of savings, or you have arranged your own personal pension, then you are in a defined contribution scheme.
With defined contribution schemes, once you reach age 55, you can draw out some or all of your savings at any time as cash lump sums, income or a combination of both. For an overview of all your options, see our guide on ways to use your pension pot.
One of the ways you can do this is using drawdown.
How does drawdown work?
Typically, you would consider drawdown once you feel ready to start drawing some retirement income.
You can take up to a quarter of your pension pot as tax-free cash. The rest of your pot is then moved into a drawdown fund. The fund is invested, for example in shares and bonds. You cash in part of the fund on either a regular or ad hoc basis to provide yourself with income or lump sums as you need them.
How much income you can afford to take out and how long your savings will last depends on how your investments perform. So you might need to reduce your income in some years, but be able to take more in others. There is no guarantee that your savings or income from them will last for the whole of your retirement.
On the other hand, there could be savings left in your drawdown fund when you die and these can be passed on to your heirs. It’s important that you tell your pension provider who you would like to receive these savings, so that they can be passed on free of inheritance tax.
Ways to take an income
There are two main ways to provide yourself with a drawdown income:
- Draw out a series of lump sums at regular intervals.
- Use part of your pension pot to buy a short-term annuity. This is a product you buy with a lump sum that provides you with a secure regular income for say up to five years. For example, you could use a short-term annuity to provide yourself with a basic income and, to top this up, cash in part of the rest of your pot on an irregular basis.
You can carry on using income drawdown for as long as you like. At any time, you can use your remaining pension pot to buy a lifetime annuity, which is a type of insurance product that guarantees to pay you an income for the rest of your life.
If you could not manage on an income that might go up and down, you might want to look at using at least some of your pension pot to buy a lifetime annuity straight away.
Not all providers offer income drawdown. Even where the rules described above do not impose any restrictions, individual providers may set their own rules. So you should carefully check the terms and conditions for any scheme you are interested in.
Deciding whether income drawdown is right for you is a complex decision so you might well want to seek financial advice. You can find details of independent financial advisers in your area on the unbiased.co.uk website. You can also get more information and guidance from the free and impartial government website Pension Wise.