Drawdown & Annuity Pensions

How pension drawdown works

You can normally choose to take up to 25% (a quarter) of your pension pot as a tax-free lump sum. Some older policies might allow you to take more in tax-free cash.

You then move the rest into one or more funds that allow you to take a taxable income at times to suit you. Increasingly, many people are using it to take a regular income.

You set the income you want and it’s a good idea to review this and adjust it depending on the performance of your investments.

Once you’ve taken your tax-free lump sum you can start taking the income right away or wait until a later date.

You can also move your pension pot gradually into income drawdown. You can take up to a quarter of each amount you move from your pot tax-free and place the rest into income drawdown.

Your provider will ask you how you want to invest your remaining pot when you move into income drawdown. You will either need to choose your own investments, i.e., one’s that match your attitude to risk and objectives for your money, or, some providers will offer you to choose from simple ready-made investment options which are linked to your retirement plans (these are called Investment Pathways). You could also use a financial adviser to help you choose.

An investment pathway is a ready-made investment option, which simplifies the decision of how to invest your remaining pension pot after you’ve taken your tax-free lump sum.

As with all investments, the value of your pot can go up or down.

Using drawdown funds for other products

To help provide more certainty, you can at any time use all or part of the funds in your income drawdown to buy an annuity or other type of retirement income product that might offer guarantees about growth and/or income.

What’s available in the market will vary at any given time so you’ll need to discuss your options with a financial adviser.

Things to think about

You need to carefully plan how much income you can afford to take under pension drawdown otherwise there is a risk you will run out of money.

This could happen if:

  • you live longer than you have planned for.
  • you take out too much in the early years.
  • your investments don’t perform as well as you expect, and you don’t adjust the amount you take accordingly.

If you choose pension drawdown, it’s important to choose the right investment and regularly review them.

Unless you are an experienced investor, you might need help from a regulated financial adviser to help with this.

Not all pension schemes or providers offer pension drawdown.

Even if yours does, it is important to compare what else is on the market as charges, the choice of funds and flexibility might vary from one provider to another.

Comparing products, yourself will be difficult but a financial adviser can do this for you. It is the adviser’s job to recommend the product that is most suited to your needs and circumstances.

What tax will I pay?

Any money you take from your pension pot using income drawdown will be added to your income for the year and taxed in the normal way.

Large withdrawals could push you into a higher tax band so bear this in mind when deciding how much to take and when.

If the value of all of your pension savings is above £1,073,100 when you access your pot (2021/22 tax year) further tax charges might apply.

Tax relief on future pension saving.

You can normally get tax relief on pension contributions to pension schemes of up to £40,000 or 100% of taxable salary each year (if lower than £40,000). This is known as your Annual Allowance.

However, if you start to draw an income from a pension drawdown scheme, the amount you can pay into a defined contribution pension and still get tax relief reduces. This is known as the Money Purchase Annual Allowance (or MPAA).

The MPAA for the tax year 2021/22 is £4,000.

If you want to carry on building up your pension pot this might influence when you start taking income.

What happens when you die?

You can nominate who you would like to get any money left in your drawdown fund when you die.

  • If you die before the age of 75, any money left in your drawdown fund passes tax free to your nominated beneficiary whether they take it as a lump sum or as income. The money must be paid within two years of the provider becoming aware of your death. If the two-year limit is missed, payments will be added to the income of the beneficiary and taxed as normal.
  • If you die after the age of 75 and your nominated beneficiary takes the money as income or a lump sum, the money will be added to their other income and taxed as normal.

Is pension drawdown right for me?

Pension drawdown is a complex product. A regulated financial adviser will be able to recommend whether it is suitable for you.

What is an annuity?

An annuity is a type of retirement income product that you buy with some or all your pension pot. It pays a regular retirement income either for life or for a set period.

Annuities – the basics

Annuities are retirement income products sold by insurance companies.

They include:

  • Lifetime annuities – which pay you an income for life and will pay a nominated beneficiary an income for life after you die if you choose this option; they include basic lifetime annuities and investment-linked annuities.
  • Fixed-term annuities – which pay an income for a set period, usually five or ten years, and then a ‘maturity amount’ at the end that you can use to buy another retirement income product or take as cash.

When you use money from your pension pot to buy an annuity you can take up to a quarter (25%) of the amount as tax-free cash.

You then use the rest to buy the annuity and the income you receive is taxed as normal income.

How much retirement income you will get from an annuity – and for how long, will depend on:

  • Your health and lifestyle
  • How big your pension pot is?
  • Annuity rates at the time you buy.
  • Where you expect to live when you retire
  • Where you expect to live when you retire
  • How old you are when you buy your annuity.
  • Which annuity type, income options and features you choose

Once you buy an annuity you cannot change your mind, so it is important to get help and advice before committing to one.

To find out more about the different annuity types – and the different options and features you can choose when buying them you should contact a regulated independent financial advisor (IFA)

Higher income for medical conditions or unhealthy lifestyle

If you have a medical condition, are overweight or smoke, you might be able to get a higher income by opting for an ‘enhanced’ or ‘impaired life’ annuity.

Not all providers offer these so be sure to shop around if you think you might benefit from one.