Some of the benefits and risks of flexi-access drawdown

Weighing up the pros and cons of drawdown

As the name suggests, the main benefit of flexi-access drawdown for many people is its flexibility. It also brings the potential for your pension savings to grow through investment performance.

But there are some potential downsides, too. These include the risk that your invested pension fund might fall in value if markets do not perform as you would wish. In the worst-case scenario, your fund could run out earlier than anticipated.

Flexi-access drawdown – how it works

Drawdown is one way to turn money from your defined contribution (money purchase) pension savings into income. It works by investing your pension fund and letting you take money from it as regular income or ad hoc payments. 

You are usually entitled to take up to 25% of your pension savings as a tax-free lump sum upfront. You can then move the rest into drawdown. You also have the option of moving your money into drawdown gradually, taking 25% tax-free each time.

You can read more about how drawdown works in our detailed guide to flexi-access drawdown.

There are alternatives to drawdown, including an annuity. With this option, you swap your pension fund for a guaranteed income, unaffected by investment performance. If you take a lifetime annuity, you will continue to receive income for life, with no risk of running out of money. As with drawdown, you have a 25% tax-free lump sum allowance with an annuity.

Drawdown and annuities are both options you can take from the age of 55 (changing to age 57 from April 2028). However, you can wait and start taking an income from your pension savings later on, for example, if you retire at a more typical retirement age of 65+.

Benefits of flexi-access drawdown

Drawdown offers a blend of flexibility, the potential for investment growth and built-in death benefits for your beneficiaries. 

Here are five of the main potential benefits of drawdown:

1. Take your money when you wish

Drawdown lets you take money from your pension savings whenever you want, either as regular income or as ad hoc payments. You can change how you access your money as your needs change. It lets you keep your options open should something unexpected happen in the future.

It also lets you plan your withdrawals and future income to reduce your liability to tax. For example, you may be able to delay a withdrawal until the next tax year to avoid going into a higher tax bracket.

2. Flexibility to choose an alternative retirement income product in the future

Choosing income drawdown does not commit you to it forever. You have the option of switching to another form of retirement income in the future.

For example, you can typically decide to use money in your pension fund to change from drawdown to an annuity at any time, if you later decide to opt for guaranteed income.

3. Potential for investment growth

Your fund remains invested so it has the potential of growing significantly if the markets perform well. This could boost your overall retirement income or mean that your pension pot lasts longer than anticipated.

Potential future investment growth is free from income tax and capital gains tax. You might therefore pay less tax on investment return with drawdown than if you had money invested elsewhere. But remember that the income you take from drawdown is taxable once you have used your 25% tax-free allowance.

4. Investment control

You remain in control of your fund and its investments. You can decide how much risk you wish to take and choose where to invest your pension fund accordingly. You’ll also typically have the flexibility to change your investment choices whenever you wish.

5. Valuable death benefits for your loved ones

With drawdown, unused funds are automatically passed on to beneficiaries upon your death. This is not the default arrangement with an annuity, but you can choose to add annuity death benefits. With both products, your beneficiaries will pay no tax on the money if you pass away before age 75, but tax is payable if you pass away after 75.

Risks of flexi-access drawdown

The potential downsides of drawdown include the risk of your pension fund losing value and therefore your income running out sooner than you would like.

Here are five of the main potential risks of drawdown:

1. Investment uncertainty

Because your pension savings are invested, they will be subject to uncertain investment returns. There is no guarantee of your fund increasing in value – and it could fall in value if markets perform badly. 

This means that your income is not secure with drawdown. Poor investment performance could mean you receive less income than you might be anticipating, or that you run out of money sooner than you think.

2. You need to manage your fund and withdrawals

Drawdown isn’t always a great choice if you don’t want to be involved in your retirement income. Ideally, you need to proactively manage your investment and withdrawals – or pay a financial adviser to do this for you.

For example, you may wish to move money from high-risk to low-risk funds in certain market conditions or if your attitude to risk changes. Also, you may wish to carefully monitor your withdrawals to avoid taking out too much, too soon.

As you can see, flexi-access drawdown may require careful management in order to ensure that you do not run out of money. This is something to bear in mind if you do not wish to have the potential hassle of managing your retirement income for years to come.

3. You could miss out on high annuity rates

Some people choose drawdown initially, anticipating buying an annuity for guaranteed income at a later date. However, annuity rates change and there is no guarantee that your future income from an annuity will be as high as that offered by an annuity purchased today.

4. Charges

Initial and ongoing charges for setting up and managing your fund apply and these vary a great deal. It is therefore important that you fully understand how much a drawdown provider charges, remembering that charges will reduce the value of your fund, and ultimately your income.

It’s not always easy to compare drawdown providers’ fees as they each have their own charging structures. You may therefore benefit from taking advice from an independent financial adviser who can decipher each provider's charges.

5. Your entitlement to state benefits could be affected

An income from drawdown could affect your entitlement to means-tested benefits including Pension Credit, Housing Benefit and Council Tax Support. 

Crucially, national or local government agencies may also take into account how much money you could receive from drawdown, and not just your current income from it. 

Helping you compare your options

If you are considering drawdown but would also like to look at how an annuity might work for you, we can help. Even if you are unsure whether an annuity is right for you, it costs nothing to talk to one of our Annuity Specialists. They can provide comprehensive information about this option and personalised quotes from the UK’s leading annuity providers.

As the UK's largest pension annuity broker*, we specialise in helping people aged 55+ shop around for the best annuity rates and income. You can use our free annuity calculator to see how much income you could secure with an annuity - or call us on 0800 652 1316 or request a call back to talk to one of our friendly team today.