How Does Pension Drawdown Work?
Pension drawdown is simply a way of taking an income from your pension in a flexible way.
Before 2015 you’d typically exchange your pension for an insurance product called an annuity that provided you with a guaranteed income for the rest of your life.
Annuities can still be the right thing for you to do (especially if you want to keep things simple) but they lack the flexibility that pension drawdown offers.
With pension drawdown, you can access as much or as little of your pension as you want (but there could be serious tax consequences if you take the whole lot out in one go!).
Annuities are still around but, even though annuity rates have improved, people have got use to the flexibility of pension drawdown and most take this option.
Pension drawdown means keeping your money invested (hopefully, to achieve long-term growth) but there are no guarantees and it also means you need to stay on top of things like performance, investment risk, etc.
For many, taking the pension drawdown route means hassle whereas an annuity is far more straightforward. That said, an annuity has FAR less flexibility and it’s the flexibility that’s appealing for people.
Typical Pension Scenario
So, you’ve retired and you have a pot of money in a single pension (or bunch of pensions). You like the idea of wanting to adjust the income (or lump sums) you take from your pensions, perhaps because:
You’ve got some big expenses at the moment but they’re going to go down in years to come.
In a few years you’ll start getting your state pension so you’ll need less income from your pension fund.
You may need a lump sum to periodically change the car or go on a big holiday.
Maybe you’ll want to pull out a chunk of money to help the children / grandchildren out.
You like the idea of having funds to call on if something unforeseen happens.
Whatever the need, pension drawdown gives you flexibility. That said, typically, only 25% of the pension drawdown fund can be taken tax-free and the rest of it is taxable so you DO need to be careful.
So, you can see that pension drawdown is all about flexibility. I know I’ve used that word A LOT but there’s no getting away from it.
Potential Downsides of Drawdown
As I’ve said, with pension drawdown, you’ll remain invested so you need to understand the value of your pension drawdown fund can go down.
There are also ongoing costs. You’ll need to pay the fees of the pension drawdown provider you’re with, the fund managers investing your money and, perhaps, a financial adviser.
This means you need to stay involved with how it’s invested and the amount of risk you’re taking. You also need to be aware of the impact your withdrawals will have on the fund. Will the money run out?
You’ve got to stay engaged. Pension drawdown will need your ongoing attention and there are no guarantees that it will outlive you (rather than you outliving it!).
I suppose I’m bound to say that it makes sense to use a financial adviser to manage a good chunk of this for you and to take some of the hassle away but you certainly don’t have to.
it’s not rocket science but there are things / nuances you’ll want to be aware of with pension drawdown. It can be an excellent way of managing your income in retirement, provided you go in with your eyes open.
I Hope This Helped
As I said at the start, I didn’t want to get overly technical but I hope I’ve got across, at least at a high level, the features, benefits and downsides of drawdown.
If you feel a chat might be useful do get in touch or if you want to have a look at any other scintillating blogs I’ve written, feel free to check them out here.
That’s it all for now folks!...