What is income drawdown?
Income drawdown is simply a term used when your pension scheme allows you to take a flexible income from your pension pot, whilst leaving your remaining pot invested. You get to choose the frequency and the amount of money you want, based on your needs. If your circumstances permit, you may even choose not to take an income from your pension, either temporarily or permanently, for the benefit of your beneficiaries, for instance.
With older pension schemes, it was mandatory to purchase an annuity at retirement. You can still use all or part of your pension pot to purchase an annuity if that meets your specific requirements.
There are two types of drawdown pensions:
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Capped drawdown
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Flexi-access drawdown
What is a flexible drawdown pension?
Flexible drawdown enables you to take as much or as little income from your pension pot as you like with no maximum limit as long as you have reached the minimum pension age. The minimum pension age is currently 55, but the government has stated that it will increase to 57 by 2028.
You could potentially draw down your entire pension pot, however, you will need to pay income tax on the amount of money you draw at your marginal rate for that tax year.
Any income drawdown arrangement set up since the Pensions Freedoms legislation was introduced in April 2015 will automatically be classified as flflexible drawdown pensions.
Are you eligible for flexible drawdown?
Anyone is eligible for flexible drawdown, however, your existing pension may not allow flexible drawdown. You are free to set up a new pension at any time and transfer your pension to a scheme that offers a flexible drawdown facility.
You should always talk to an Independent Financial Advisor before transferring your pension, as some pensions offer guaranteed benefits or apply transfer charges that mean that transferring your pension is not in your best interests.
How is your pension drawdown taxed?
You are entitled to 25% of the value of your pension as a tax-free lump sum. This is known as your Pension-Commencement Lump Sum (PCLS). Any withdrawals drawn down over and above your PCLS are subject to income tax at your marginal rate.
You can utilize your personal allowance (£12,570 in 2021/2022), so some or all of the income could potentially be taken tax-free. Any income above this would be taxable, and your pension scheme provider will deduct tax from the money you draw down, using the Pay As You Earn (PAYE) system to calculate the tax due, taking into account the personalised tax code that HMRC have provided you with.
Sometimes, the tax on your drawdowns is deducted incorrectly. If this happens, you are responsible for ensuring the right amount of tax is paid each year, so you may need to complete a self-assessment tax return.
Often, the first payment is taxed using the emergency code, resulting in an overpayment. Again, it is your responsibility to claim this back from HMRC.
Can you contribute to a pension after drawing income?
It is still possible to contribute to your pension after you have started taking an income from it. However, this may reduce the maximum amount that you can contribute and receive tax relief.
If you have already taken an income from your pension, your annual maximum allowance will reduce to £4,000 for all future contributions to defined contribution pensions.
The reduction in your annual allowance is triggered when you take an income from your pension. If you have never taken any income from your pension, you still get the standard maximum annual allowance of £40,000.
These rules do not apply to withdrawals from capped drawdown pensions. If you have a capped drawdown pension, you can continue to contribute to your plan, subject to the standard maximum annual allowance of £40,000, provided that your withdrawals are kept within the maximum limit.
How much does it cost to draw down your pension?
Due to the greater level of administration required, pension scheme providers usually charge a fee to set up and facilitate drawdowns from your pension. This means that the overall pension charges could be higher than pensions with other pension income options. You may also face additional costs associated with financial advice and administering the investments within your pension pot.
You should always check your pension scheme charges to ensure they are cost-effective and competitive.
What happens to your drawdown pension when I die?
If you die and your pension pot still has a value, any remaining balance will be passed on to your nominated beneficiaries and will not normally be subject to inheritance tax. Your beneficiaries can take flexible income from your pension, or they can withdraw the balance as a one-off lump sum.
If you die before age 75, any income or lump sums passed on to your beneficiaries will be tax-free. If you die after age 75, income or lump sums will be taxed at your beneficiary's marginal rate of income tax.
What is the next step?
Pensions are complex and you need to ensure that you are armed with the correct information, based on your personal circumstances and objectives, in order to make an informed choice when choosing, or transferring, any pension plan. It is recommended that you take professional financial advice to ensure that you have the correct plan to meet your needs and that you are on track to meet your retirement goals.
Connect with an expert through our network of UK-qualified Independent Financial Advisors. Through our introduction, you will be entitled to a free, no-obligation pension review.