What Is Pension Drawdown? What Are Its Benefits and Risks?

Summary

• Pension drawdown, or income drawdown, is the way of taking out your pension money to live on in retirement.
• Depending on the tax structure you want to choose, different types of pension drawdown options are available.

The Pension drawdown can be defined as a way of utilising your accumulated pension money and offer you a regular income post retirement by investing your funds in schemes especially designed for this purpose.

Understanding Drawdown

The scheme offers you the flexibility to withdraw your fund when you need it, and you may keep the remaining fund in the scheme, which will continue to grow. You have to manage your withdrawals and also manage how well your invested money is doing over a period of time.

You are allowed to withdraw pension funds after you turn 55. However, any UK resident will be liable to pay income tax on any amount drawn more than his or her personal income tax allowance limit. So even if you start withdrawing from your pension pot, you will be liable to pay income tax depending upon the drawdown payments. Only 25% of your pension pot can be tax-free once you opt for drawdown. Once you opt for pension drawdown, the amount you can put in your pension pot goes down.

A Pension drawdown tax calculator can help you calculate the income tax liability on your drawdown payments. This tool can be used either by the pension fund holder or his/her financial advisor to work out how much income tax needs to be paid for a particular drawdown payment.

Also Read: What Is The State Pension? Does Everyone In The UK Get A State Pension?

People spend their life savings towards the pension fund and ultimately wants to know how they can effectively withdraw their accumulated fund. Here are the ways by which one can withdraw funds.

Types of Pension Drawdown

Flexi-access drawdown

Flexi-access drawdown is the most common option available to withdraw from your pension pot. Under this option, you are allowed to take up to 25% of your pension savings upfront, which will be tax-free. However, you cannot opt-out of this scheme later. The remaining 75% can be withdrawn at any time with no capping on withdrawal. You can withdraw all in one go or take monthly/quarterly regular payments. 

Uncrystallised Fund Pension Lump Sum (UFPLS)

Uncrystallised Fund Pension Lump Sum, or UFPLS, is another way of drawing money from your pension pot. However, unlike Flexi-access, the UFPLS does not allow the option of taking upfront 25% tax-free cash lumpsum payment.

In this option, for each drawdown payment you take, 25% of it will be tax-free, and the rest amount will be liable for income tax at a marginal rate. 

Benefits of Pension Drawdown

1. Flexibility: You can withdraw your income whenever you want, and the withdrawable amount can also be adjusted as per your requirements.
2. No compulsory withdrawal: This is the second and foremost benefit of the pension drawdown scheme. You can choose to remain invested even after your retirement, and withdrawing your funds after a certain age is not compulsory.
3. Tax-free lumpsum: Getting 25% of your pension funds tax-free is also a significant benefit of the scheme.

Disadvantages and risks

1. No guarantee: The returns are not guaranteed, as the scheme invest your funds mainly in the stock market. Hence, your pension pot may go below its original value due to the fluctuations in the markets. Therefore, you need to plan carefully to have enough money to last your entire retirement.
2. Time-consuming: Selecting the pension drawdown scheme will consume a lot of your time. Choosing a scheme will involve selecting the best option from all the available options based on your financial requirements and risk tolerance level. Once the scheme is finalized, you need to monitor the scheme closely.

Other clauses

So, what happens to the scheme if the holder dies?  There are two case scenarios:

If the Pension Drawdown scheme holder dies before 75: All pension funds left can be inherited by his family or kin and will be tax free. This could be taken as a regular income from your drawdown plan.

If the scheme holder dies after 75: The inheritors of the pension funds need to pay tax at a marginal rate.

Since its launch in April 2015, pension drawdown schemes are popular as they are highly flexible as there is no upper limit on withdrawal of the funds. One can withdraw as much as one want. However, money should be withdrawn wisely and only when it is required. One can also seek advice from their financial advisor to understand the complications associated with the scheme.