What is pension drawdown?

What tax will I pay on drawdown income?

You'll pay tax on your income in the following way:

Tax-free portion

When you move money from your pension pot into drawdown, you can take up to 25% of it as a tax-free lump sum. 

Taxable portion

The remaining 75% of your pension pot is taxed as income at your marginal rate. This means it’s taxed the same way as most other income. You'll still enjoy a personal allowance of up to £12,7570, and only a pay a basic rate tax of 20% on income up to £50,270. Any income you take after that will be taxed at a higher or additional rate.

Here are the income tax bands for the tax year 2024/25:

For example, if you received a combined retirement income of £20,000 a year from your State Pension and your pension drawdown, you would pay: 

• 0% tax on the first £12,570 = £0
• 20% tax on the remaining £7,430 = £1,486
• So your total tax due for the tax year would be £1,486
• If you took any additional drawdown payments, you might be pushed into a higher tax bracket

Please note that these rates are correct for England, Wales, and Northern Ireland. Rates in Scotland are slightly different, and rates may change in future tax years.

What do I need to consider before taking out drawdown?

• Investment Knowledge: Pension drawdown means investing your money in the stock market. Make sure you understand how it works and the risks involved.
• Income Requirements: Think about how much money you need during retirement. If you need a steady income, an annuity might be better for you.
• Life Expectancy: Your health and how long you expect to live can affect if drawdown is a good choice. If you live a long time, you might use up all your pension savings.
• Tax Implications: Withdrawing too much from your pension pot each year could put you in a higher tax bracket. Make sure you understand the tax implications.
• Charges: Pension drawdown products have charges that can reduce your retirement savings. Understand all the costs involved.
  Inheritance: If you want to leave some of your pension to your heirs, drawdown might be better. It can be passed on tax-free if you die before age 75.
• Flexibility: Drawdown is more flexible than an annuity. You can change your income and make lump-sum withdrawals. But, this flexibility comes with risks and responsibilities.
• Professional Advice: Pension decisions are complex and have long-term effects. Get independent financial advice before deciding. Everyone's situation is different. Take your time and make the right decision for you.

How does drawdown affect my benefits?

Taking a lump sum from your pension via drawdown could affect your entitlement to meant-tested benefits. These benefits include Universal Credit, Housing Benefit or Pension Credit. It could also affect Employment and Support Allowance, Income Support and Jobseeker’s Allowance.

How often can I take payments on pension drawdown?

Pension drawdown allows you to choose how often you want to take payments. You can take regular withdrawals just like an income or dip into the pot when you need it. There's no limit on how much you can take out each year but large withdrawals could push you into a higher tax bracket and you should be careful that your pot doesn't run out. 

What costs are involved in drawdown?

There are ongoing costs involved in pension drawdown. Here are some examples:

• Set-up fees: These are typically a standard fee or a percentage cost based on the size of your pension pot
• Administration fees: These are typically a standard fee but some providers may calculate costs based on how much you have in your pension pot
• Withdrawal fees: These are either on the initial 25% tax-free lump sum and/or each additional withdrawal
• Exit/Transfer fees: Moving to another provider may incur fees based on the size of the pension pot

Is drawdown right for me?

Whether pension drawdown is right for you depends on several factors, and is a completely unique decision only you can make. Here are some things to consider:

• Attitude to risk: Pension drawdown involves investment risks. If your investments perform poorly, your income could decrease. Are you comfortable with this risk? If you prefer knowing that you’ll have a guaranteed income, an annuity might be a better option
• Flexibility: Once you have set up a pension annuity, you can’t cash it in or make any changes, while you can draw down money as you need it. You can also combine annuity and drawdown products – it’s not an either or decision
• Health and lifestyle: If you have health issues, an enhanced annuity (which can provide a higher income for those with shorter life expectancy) might be more suitable
• Financial understanding: Pension drawdown can be complex and requires ongoing management. Do you feel confident managing your investments or would you prefer the simplicity of an annuity?

Before making any decisions about your retirement income, it’s important to make an appointment with Pension Wise. It's a free government guidance service from MoneyHelper. You might also want to speak to a financial adviser. If you don’t already have one, you can find one at Unbiased.