Understanding pensions – what is drawdown?
by Alexander Beard, on Sep 26, 2016 6:54:58 AM
Drawdown is a way of achieving greater flexibility with your pension funds. Every time you move your money into drawdown, you’re allowed to take 25% of this as a lump sum, which is exempt from tax. The rest continues as an investment, with taxable income able to be drawn straight from your pension whenever you choose. The tax-free lump sum must be taken at the start, but as you don’t have to move your whole pension at once, multiple lump sums can potentially be taken.
Another attractive feature of drawdown is the greater flexibility it allows you in withdrawing your pension. You can choose regular withdrawals monthly, quarterly, biannually or annually, as well as having the option of taking one-off lump sums or taking a break from withdrawing whenever you like. Anything left after your death can be passed on to beneficiaries nominated by you.
When it comes to withdrawals, many people choose to only draw the ‘natural yield’ – the income that their underlying investments generate, which could come from funds, shares or corporate bonds. Another method is ‘drawing on capital’, which involves the sale of investments to generate cash which can be withdrawn. If you withdraw more than the amount by which your pension is growing, however, choosing to draw on capital will lead to your pension value going down over time.
One important aspect of drawdown that is essential to keep in mind is that it does not offer the secure income that other forms of pension do, such as an annuity. Your money could run out if you live for longer than you anticipated, you simply withdraw too much, or your investments underperform based on your expectations.
As with any form of investment, there is an element of risk with drawdown. There will be variations in your yields over time, and you may end up receiving less than the amount you invested. Whether drawdown is right for you ultimately depends on how you weigh up the benefits of greater flexibility against the risks of investment and the possibility of running out of money.