If you’re approaching retirement, you may have started thinking about how you will use your pension pot. Should you buy an annuity or should you consider arranging a pension drawdown?
In this guide, we take a look at everything you need to know about pension drawdown. We also answer common questions like “Are there any alternatives to a pension drawdown?” and “What are the pros and cons of pension drawdown?”.
What is pension drawdown?
Pension drawdown, sometimes called income drawdown, is a way of withdrawing your pension savings to give you a flexible retirement income. It’s an alternative to arranging an annuity where you use your pension pot to buy a guaranteed income for a set period.
With pension drawdown, your pension stays invested and you gradually withdraw an income. This can be done on a flexible basis, sometimes withdrawing more income than at other times.
Because your pension pot stays invested it means that your pension pot can carry on growing over time. However, there is the risk that your pension will go down in value if your investments do badly.
How does pension drawdown work?
Pension drawdown works by gradually withdrawing money from your pension pot. The rest of the pension pot remains invested. The income drawdown works like this:
You can usually withdraw the first 25% of your pension pot tax free before you make a decision about whether to buy an annuity or do income drawdown. You will have to pay income tax on the remaining 75% of your pension just like any other income.
You choose whether to set up an income drawdown or buy an annuity, usually with the advice of a financial adviser.
You can also choose to take part of your pension as income drawdown and part as an annuity. This is called partial drawdown.
Once you set up a pension drawdown, you gradually withdraw money from your pension pot. Your pension withdrawals are flexible and you can choose how often and how much you take out of your pension.
The rest of your pension pot will remain invested in your chosen funds. This means that your pension can go down in value as well as up, and your income isn’t guaranteed.
It’s possible to run out of money if you live for longer than expected, your fund doesn’t grow as much as expected, or you withdraw too much.
It’s also possible to still have some of your pension pot left when you die and leave some money to pass on in your estate.
Should I transfer my drawdown pension to another provider?
Even if your current provider offers income drawdown, it’s worth considering transferring your pension to another provider. Drawdown fees and the choice of funds vary significantly between pension providers, so your existing pension company might not be the best option for you.
Check with a financial adviser that you won’t lose any valuable guarantees or have to pay charges if you transfer your pension.
How do I find and compare pension drawdown options?
You can arrange an income drawdown with your current pension provider or a different pension company. It’s a good idea to shop around as fees and charges vary between pension providers.
When you’re comparing pension providers, you should consider the following:
Have you had advice on your pension options? An independent financial adviser may suggest a pension company that’s the most suitable for you and your circumstances.
Does the provider offer suitable funds for your investment?
What fees and charges does the provider charge?
How do pension drawdown charges work?
Pension providers charge various fees and charges to cover their costs and make money on their pension schemes. If your pension has entered the drawdown phase, then you may be charged the following:
Fund charges. These are often a percentage of the value of the fund.
Annual charges. These can be a percentage of the total pension fund or a flat fee.
Drawdown fees. These are charged when you set up or do an income drawdown.
Why is it important to get advice on the right drawdown provider?
It’s important to get advice on your pension drawdown options. That’s because it’s a big financial decision that will affect your retirement income for many years in the future.
A financial adviser will look at all your circumstances, your attitude to risk and your financial goals before advising you on the best option. For example, if you would prefer a guaranteed income in retirement, then buying an annuity may be a better option for you than income drawdown.
What types of drawdown pension are there?
There are 2 main types of drawdown pension:
Pension drawdown. Sometimes called flexi-drawdown, the rules changed in April 2015 so that there’s no limit to the number of drawdowns or the amount you can take from your pension pot.
Capped drawdown. This was available up to April 2015 with more restrictive rules than recent schemes. If you have this type of arrangement then you can convert it to a flexi-drawdown scheme.
Which are the best performing drawdown pensions?
The performance of your drawdown pension depends on the growth of the funds you have chosen and the fees charged on your pension. Higher pension fees will eat into your pension wealth.
The best drawdown pension provider in 2021 is Vanguard, according to research by the Times Newspaper. They found that Vanguard has very low charges, no additional SIPP admin fee, no set-up charges, annual admin fee or account closure fees. Vanguard also has a free drawdown set-up and withdrawing your pension is free.
According to research by the Times Newspaper, the best drawdown pension providers in 2024 are Vanguard, Aviva, interactive investor and AJ Bell.
What are pension drawdown tax rates?
The first 25% of your pension drawdown will be tax free. The remaining 75% of your pension is classed as taxable income just like other types of income. All your income is added together to give your total taxable income and is taxed at the following rates:
Income between £12,571 and £50,270 is taxed at 20%
Income between £50,270 and £125,140 is taxed at 40%
Income over £125,140 is taxed at 45%
The income tax rates are slightly different if you live in Scotland.
Are there any alternatives to a pension drawdown?
Buying a pension annuity is the main alternative to pension drawdown. With a pension annuity, you use your pension pot to buy a guaranteed income in retirement.
There are different types of pension annuity as follows:
Lifetime annuity that will pay out until you die
Fixed-term annuity that will pay out for a certain guaranteed period
Level annuity that remains the same over time
Increased or inflation-linked annuity that goes up over time
Joint-life annuity that will pay out to your survivor after your death
Partial annuity where you buy an annuity with part of your pension pot
With pension annuities costing more than ever, many of us are considering pension drawdown when we retire. It means your pension will remain invested so it can lead to more income in retirement. The downside is that you don’t have a guaranteed income, so you’re taking the risk that the value of your investments goes down. That’s why some people decide to get the best of both worlds and mix and match a partial income drawdown with a smaller annuity.
Whatever you decide, make sure you get some independent financial advice on how to set up your pension in retirement.
What are the pros and cons of pension drawdown?
The pros and cons of taking a pension drawdown depend on your personal circumstances. Here are some of the most common pros and cons:
Pros
Your pension pot can continue to grow, even into retirement. That’s because it will remain invested in the stock market, so your fund will increase in value if the stock market goes up.
Can be better value than a pension annuity as you are taking the risk, rather than the pension company.
Flexible as you can take as much income as you wish. You can also decide to buy an annuity later on with your pension pot.
May grow over time if the stock market increases in value.
You may be able to pass on some of your pension pot when you die if you don’t use it up.
Cons
Risk that your pension loses value if the stock market goes down in value.
No guaranteed income like an annuity.
You may run out of money if you live for longer than expected.
Bottom line
Pension drawdown can lead to a higher pension income than a traditional annuity. That’s because your pension pot can continue to grow even once you’re retired. The flip side is that there is always a risk that your pension pot will decrease in value if the stock market goes down in value.
Make sure you get advice from an independent financial adviser who will be able to advise you on your pension options. They can take into account your individual circumstances and find a pension option that is right for you.
Frequently asked questions
Pension drawdown allows you to keep your pension pot invested, so you may get a higher pension income in retirement. However, your pension income isn’t guaranteed and could go down in value if the stock market crashes.
Buying an annuity with part or all of your pension pot may be a better option if you would prefer a guaranteed retirement income or if the pension is your only source of income.
Most drawdown pensions have no limit on the number of times you can draw down income from your pension. However, you should check the rules of your scheme to see if any charges apply.
You don’t need to use a financial adviser to arrange a pension drawdown, but it is usually a good idea. This is because deciding how to take your pension income is an important and complex financial decision. A financial adviser will make sure that an income drawdown is suitable for you and advise you on the best drawdown pension provider.
How much tax you will pay on your drawdown pension depends on your overall income. You will pay income tax on pension income just like any other type of income. However, you won’t pay any national insurance on pension income.
You’re allowed to take the first 25% of your pension tax free, but you can’t avoid tax on the rest of your pension.
You might be able to reduce your tax bill by withdrawing your pension more gradually. Taking your pension in one go may push you into paying higher tax in this year, whereas withdrawing your pension more gradually will make sure you’re using all your personal allowance each year.
A SIPP, or self-invested personal pension, is a type of pension scheme. It can be used by people still paying into their pension or people in the drawdown phase of their pension.
Drawdown is a phase of your pension scheme rather than the name of a type of scheme. Your pension is in the drawdown phase if you’ve started taking money out of your pension scheme.
Finder survey: Do you currently plan to spend all of your pension before you die?
Response
Female
Male
Not sure
46.69%
40.49%
No
24.7%
28.8%
Yes
21.69%
27.17%
Prefer not to say
6.93%
3.53%
Source: Finder survey by Censuswide of 1032 Brits, December 2023
Pensions are long-term investments. You may get back less than you originally paid in because your capital is not guaranteed and charges may apply. Keep in mind that the tax treatment of your pension and investments will depend on your individual circumstances and may change in the future. Capital at risk.
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Alice Guy is a Suffolk-based finance writer, a busy mum of 4 older kids and a self-confessed personal finance geek. She trained as a chartered accountant with KPMG London before working for Tesco Plc as a business analyst. She loves to write about budgeting, saving, investing and building wealth. See full bio
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