Income drawdown: things to consider

Written by Retirement Line

Income drawdown is one of the ways you can take an income from your defined contribution (money purchase) pension pot. With this option, your pension savings remain invested and you take either a regular income or ad-hoc withdrawals until your pot is empty.

This contrasts with an annuity, where your contribution is not invested and can provide a guaranteed income for life or a fixed term.

Our guide to income drawdown has comprehensive information on how drawdown works. To supplement that guide, here are some important points you may wish to consider when thinking about the suitability of drawdown.

On this page:

• Would a ‘blended’ retirement income approach work for you?

• Understanding your investments

• Planning for a long life

• The effects of inflation 

• Drawdown costs

• Any other sources of income

• Impact on state benefits and on debts

• Are you in capped drawdown? 

• The pension recycling rules

Would a ‘blended’ retirement income approach work for you?

First of all, remember that you don’t have to put all of your pension pot into one income option. You can instead take what’s sometimes called a ‘blended’ approach. This can be done in a number of ways, depending on your circumstances.

For example, one part of your pension savings can be used to buy an annuity, providing you with a guaranteed level of secure income for life or a fixed term, possibly to cover your essential living costs. The rest of your pension savings can then be placed into drawdown to provide flexible additional income to supplement your annuity income.

This is just an example, and it may suit you better to make a straight choice between drawdown, an annuity, or other options. You may wish to take professional financial advice to help you decide what’s best for you.

Understanding your investments

The money you keep in your drawdown fund will be invested. You’ll therefore need to make sure you choose the right investments to match your attitude to risk and hopefully secure the investment growth you need to meet your income requirements. 

Investments are complex but generally those with greater risk produce higher returns but usually with a more uncomfortable ride than those with lower risk.

Planning for a long life

Unlike a lifetime annuity, flexi-access drawdown does not guarantee you a secure and guaranteed income for life. There is a risk that you might run out of money with years of your retirement ahead of you. But on the other hand, there is also the potential for your investment to do well while in drawdown. 

You can guard against running out of money by limiting how much you withdraw. You may decide, for example, to keep your withdrawals to less than 5% of your pension pot each year, if you feel that this might align with long-term investment performance. If your fund performs better than expected, you may decide to withdraw more income from it.

If you do choose drawdown, make sure you regularly review your fund’s investment performance and how much you are withdrawing. Regular reviews will enable you to make informed decisions about your withdrawal amounts. The government-backed Money Helper website has a guide to managing your pension fund investments in retirement.

The effects of inflation

You should be aware of the possible damaging effects of inflation, which may reduce the buying power of your pension pot and the income it pays you.

One potential strategy to address this is to invest some of your drawdown fund with the longer-term in mind. For example, you may choose to put some of your fund into stocks and shares in the hope that they out-perform inflation over a longer timeframe. 

As always, please consider talking to a financial adviser when it comes to making decisions about how you invest your pension savings. They will be able to review your circumstances and goals, and recommend a personalised investment strategy.

Drawdown costs

The flexibility and potential for growth offered by flexi-access drawdown has a cost. Charges for arranging your plan and for ongoing administration and investment management will be deducted from your drawdown account.

It is therefore important that you understand the charges you will face from your drawdown provider. These should be factored into any expectations you may have for your overall drawdown income. You can also compare the charges from different providers and shop around for the best value.

Any other sources of income

If your drawdown pot runs out, will you have any other income you can rely on? Because of the risks with drawdown, you should consider other income you may get and when you’ll receive it. 

Consider all your potential income sources, including State Pension, final salary pension, income from property, ISAs or other investments, or perhaps you’ll still be receiving a salary?

Understanding how much income you get from other sources should help you manage how much you need to take from your drawdown pot.

Impact on state benefits and on debts

Taking income or other withdrawals from your drawdown plan may affect any means tested state benefits to which you are entitled and could result in these benefits being lost. You should check the conditions of any benefits you receive before you take any money from your plan.

Money held within your pension fund is not considered part of your regular income or savings and cannot be claimed by creditors or anyone to whom you owe money. Taking money from your drawdown plan could allow creditors to claim it from you.

Are you in capped drawdown? 

Capped drawdown is a type of drawdown which allows you to take an income that’s capped at a maximum of 150% of the value of an equivalent annuity. Using capped drawdown will not affect how much can be paid into a pension in the future.

Although it’s no longer available to new customers, if you already have a capped drawdown plan, you will remain in it unless you switch to flexi-access drawdown.

The pension recycling rules

Among the various pension drawdown rules, one area that is sometimes overlooked concerns pension recycling. The pension recycling rules relate to when someone takes some of their 25% tax-free allowance and pays it back into their current pension scheme or into another one.

As you can imagine, HMRC are keen to ensure that people don’t get tax relief on the same money twice. This is why the drawdown pension rules on recycling are in place – and if you break the rules you may have to pay tax on the whole of the original tax-free lump sum. 

If you are thinking of reinvesting money from your tax-free allowance into a pension scheme, please seek professional advice.