How does income drawdown work?
With many pensions, you pay a set amount into a pension pot each month, but the income you'll get in retirement will depend on the performance of the funds where the pension provider invested the pot.
If you have this 'defined contribution' (DC) type of pension, you can opt to keep the pot invested and take out, or 'draw down', an income in retirement.
Most people who opt for drawdown will either have their money in a self-invested personal pension (Sipp) and then switch on the drawdown facility, or have their pension in a workplace or personal pension and opt for drawdown if their pension provider offers this.
Since the money stays invested (as opposed to being turned into an annuity), and it's usually in the stock market, there's obviously a risk that the fund may fall in value. The upside is that investment growth can provide higher returns and see the pot continue to increase in value.
There are two types of income drawdown – capped drawdown and flexible drawdown.
This limits how much you can draw from your pension pot, in line with rules set down by the government. The maximum you can take is 150% of the amount you would have received each year if you’d bought an annuity. People with plans taken out before April 2015 may still have capped drawdown.
Flexible drawdown (now flexi-access drawdown)
This allows you to take as much money as you want each year. People with old flexible drawdown plans will transfer automatically to the new flexi-access drawdown schemes.
What changed under the 2015 pension rules?
DC pension holders aged 55 and over are now able to access their fund however they wish – income or cash. This is irrespective of the fund size and other sources of income, which effectively means that anyone can now access flexible drawdown.
Those in capped drawdown will remain in that arrangement until they choose to move out of it.
As previously, it will be possible to take a 25% tax-free lump sum. Other funds drawn from your pension pot will be subject to the marginal rate of income tax, ie taxed as income once your personal allowance and other income are taken into account.
Before April 2015, there was a 55% tax if you died during income drawdown and you'd taken tax-free cash or drawn income.
After April 2015, the rule change has allowed beneficiaries to take a lump sum or income tax-free if you die before 75, and at their marginal income tax rate if you die after 75.
Is income drawdown suitable for me?
The main danger with income drawdown is if you take out too much money in the early years, and your investments suffer, you could end up depleting your savings and running out of money.
Keeping your money invested using drawdown will mean that you’ll give up the certainty of an annuity and risk outliving your retirement fund, and being forced to rely on the state.
Income drawdown products can come with high charges and fees.
Charges for drawdown vary considerably and will depend on the cost of the underlying investments, the product's charges and advice.
Total costs in the region of 1% to 2% a year are not uncommon and, in some cases, the overall cost for a package plus advice can reach 4%.
There are clear advantages of income drawdown if you’re happy to take control over your investment strategy.
Retirees have the opportunity for higher returns over the long term and the flexibility to change the amount of income they take each year.
Where should I get advice about this?
Given that investing can be complex, it can make sense to use a financial adviser, especially if you have little or no investment experience.
However, you can set up an income drawdown plan without advice, through either an insurance company or an investment broker.
Which? can help you choose a financial adviser.
In 2015, the government launched Pension Wise – free, impartial guidance for those about to retire to help them understand the options for their pension pot.
Pension Wise sessions are being delivered by independent organisations, including The Pensions Advisory Service and Citizens Advice.
The Money Advice Service (MAS) offers support via a retirement adviser directory for consumers who would like to find a regulated financial adviser.
Anyone with a DC pension who is approaching retirement and would like the chance to access Pension Wise can call to book an appointment on 0800 138 3944.
Income drawdown: a case study
Dennis and Lyndsey Keeling, Buckinghamshire
Dennis and Lyndsey have used income drawdown via AJ Bell Youinvest, their Sipp provider, for nearly 10 years.
They welcome the flexibility of income drawdown, especially as they've been allowed to take larger amounts since the 2015 pension changes. They plan to take larger sums when their sons want to get on the property ladder but are also conscious the pot needs to last.
Dennis said: ‘We can set the amount we want to draw down from our pension but accept the responsibility of ensuring the pension pot is adequate until our deaths.’
Which? expert view
A sensible investment strategy will ensure you benefit from the flexibility of income drawdown but don't deplete your capital.