What is Income Drawdown?
After a lifetime of accumulating and contributing to your pension pot(s), there will be some important options as to how you take your income when you reach retirement.
With a defined contribution or money purchase pension, you can choose to take up to 25% as a lump sum without paying tax.
Thereafter, one option might be that you buy an annuity, a product that guarantees a retirement income for the rest of your life (or for an agreed period).
Or another option might be that you continue to keep your pension money invested whilst taking cash as and when you need it; this option is known as income drawdown.
If you opt for income drawdown without taking the 25% tax-free cash upfront in one go as a lump sum, you can get 25% of each withdrawal tax-free instead.
For example, if you have a pension pot of say, £100,000 you are entitled to take an upfront one-off tax-free lump sum of £25,000. Alternatively, you might want to draw down an income of £1,000 per month; of this £250 would be tax-free and £750 would be subject to income tax if you are a basic or high rate tax-payer.
When opting for income drawdown, your pension pot(s) usually remains invested in a combination of equities, corporate bonds, government gilts and cash.
- Setting up income drawdown is easy but should only be considered in light of all other options available to you at retirement. Its suitability will depend on your individual circumstances and risk profile.
- The attraction of income drawdown is that at retirement, your pension money should grow as you grow older thus maintaining your chosen lifestyle.
- However, investments fall as well as rise so these downturns have to be factored in before arriving at any retirement decisions.
- As such it is vitally important that cashflow modelling projections are run first and at each annual Forward Planning meeting.
Things to think about...
- Income drawdown is a flexible way of taking a retirement income, and when markets are buoyant, there is the potential for your pension pot to grow in value.
- If death occurs before age 75, your beneficiaries can inherit the money in the income drawdown product without paying tax, whereas most annuities can’t be passed on when you die.
- There is the possibility of your income drawdown pension losing value if investments perform poorly.
- Your income drawdown pension could run out of money if you withdraw too much or live longer than you expect.
- If you choose income drawdown, you can later decide to use your remaining income drawdown pension money to buy an annuity, something you can’t do the other way round.