Income drawdown and pension freedoms

The introduction of pension freedom under the Pension Schemes Act 2015, that came into force in April 2015 has provided individuals with more flexibility, allowing them to cash in their pension pot or reinvest it instead of being obligated to purchase an annuity. 

Why were pension freedoms introduced?

Back in 2015, interest rates had been held at 0.5% since 2009 and annuity rate incomes since then have plunged to a 300 year low.

The government frustrated with the insurance companies that offered annuity contracts introduced pension freedoms that introduced a new kind of drawdown – sometimes called ‘flexi-access’ drawdown, and made it generally available. 

Before April 2015, at the time of retirement, you were either forced to purchase an annuity contract or you could enter a capped drawdown scheme, that lets you take up to 150% of the income you could have from an annuity, so far as the funds last.

With pension freedoms under the ‘flexi-access’ drawdown has no such cap, so you can take as much income as you like for as long as your fund lasts. 

The pension freedom enabled people reaching retirement age to use their pension pots however they want, rather than having to buy a guaranteed annual income.

The pension minister at the time even went as far to say it was people's "choice" whether to buy an Italian Lamborghini sports car!

What is pension drawdown?

Pension drawdown provides a flexible way to access income from your pension savings. The withdrawals are classed as income (so are subject to tax).

For example, the standard personal allowance is £12,570, the basic rate is 20% from £12,571 to £50,270. Therefore you can withdraw £12,570 from your pension pot each year and only pay 20% income tax on your state pension.

You can take as much or as little as you like, within the limits of your pension pot, but you will be subject to income tax and once your savings are gone, they’re gone.

How does drawdown work?

Setting up a drawdown scheme involves moving the accumulated money in your pension pot into a new set of investments, known as a fund.

The performance of this fund is vital since you'll be withdrawing money from it over the years.  As the fund is typically invested in assets like stocks and shares, it's subject to market fluctuations, offering both growth potential and risks.

Which providers offer drawdown?

Several major pension providers in the UK, including Scottish Widows, Royal London, Prudential, Aviva, and Standard Life, offer drawdown options for individuals looking to access their pension savings flexibly. 

If your current pension provider doesn't offer a drawdown, a financial advisor can arrange for you to transfer your funds to another pension scheme that does.

The advantages of drawdown

The main advantage is that drawdown allows you to decide how much income you get providing flexibility to meet your specific financial needs and can reduce your income and lower your tax bill at the same time.

Another possible benefit of drawdown is that you can choose and manage the investments within your pension fund. This gives you control over the potential for investment growth and allows you to adapt your investment strategy based on market conditions.

Perhaps the biggest advantage is that 100% of unused funds in a drawdown pension can be passed on to your beneficiaries upon your death free of tax. (an annuity does not form part of a person's estate). 

The risks of drawdown

Pension drawdown comes with certain risks that individuals should carefully consider. The biggest risk is that you can run out of money during your retirement. Unlike an annuity, the income is guaranteed for the rest of your life.

Another significant risk is that your pension funds are still invested in the markets so carries a higher risk than purchasing an annuity. 

Because of this risk, your fund will require ongoing attention from yourself and possibly a financial advisor to ensure funds are growing adequately.

An annuity on the other hand requires no input from either yourself or a financial advisor once set up.

How long will my pension last in a drawdown scheme?

A modest pension pot of £100,000 growing at 4% per annum would last 27 years from just a modest withdrawal of £4,000 per year (+4% per annum). If we factored in an income of £12,570, up to the personal allowance the same pension pot would last just 8 years. See calculator.

Clearly guidance, discipline and planning are required here and ongoing advice would be beneficial from a financial advisor to avoid running out of money.

Frequently asked questions

Can I add to my pension pot?

Yes, you can up to the age of 75, if you only take the tax free cash.

You are also subject to an annual allowance of £60,000.

However, once you take a taxable income, from 6 April 2023, the money purchase annual allowance (MPAA) is only £10,000. This is only 1/6th as big as the annual allowance of £60,000.

Do I have to move my whole pension into drawdown?

No, you can move a bit in at a time if you want to.

What happens to my drawdown pension when I die?

If you die up to the age of 75, 100% of your pension pot can be passed down to a beneficiary tax free.

If you die at or after 75, your beneficiaries can still withdraw what they like, but it will be taxed as their income.

What age can I go into drawdown?

Only once you are aged 55 can access the money in your pension (this is rising to 57 from 2028). This includes applying for drawdown.

However, this might be lower if you’re unable to work because of your health or are terminally ill.

What is the lifetime allowance?

As of 6 April 2024, the government will abolish the pension lifetime allowance. 

What is the annual allowance?

From 6 April 2023, the annual allowance increased from £40,000 to £60,000.

Your annual allowance is the most you can save in your pension pots in a tax year before you pay tax on your income.

How much tax free cash can I take?

You can take 25% tax free cash.

What if I decide I’d like to buy an annuity later on?

You can use some or all of your drawdown pension to buy an annuity at any time.

Get expert advice

Considering all of this, it's very important to seek financial advice before making any decisions. Taking 25% tax-free cash, purchasing an annuity or starting drawdown; you cannot reverse your decision.

Therefore, any decision needs to be based on a careful, expert assessment of all circumstances. Let Regulated Advice match you with a financial advisor for expert advice.