What is flexible retirement income (pension drawdown)?

You might be able to set up a drawdown arrangement with your current provider, or you might need to transfer to a new provider in order to use your pension pot flexibly. Even if your current provider offers this option, you should still shop around other providers to make sure that you’re making the most of your pension money.

Before you transfer, check you won’t lose any valuable guarantees or have to pay charges.

You can usually choose to take up to 25% of your pension pot as a tax-free lump sum when you move some or all your pension pot into drawdown.

The amounts you withdraw after taking your 25% tax-free lump sum will be taxable as earnings in the tax year you take them.

You’ll have to decide where to invest the 75% of your pension pot you move into drawdown.

You should choose funds that match your planned withdrawals and attitude to risk. It’s important to think about your investment choices and when you might want to make withdrawals. Remember, this income isn’t guaranteed as investments can go down as well as up. If you take out too much money too soon you could run out of money.

You can also move your pension pot gradually into income drawdown. You can take up to 25% of each amount you move from your pot tax-free and place the rest into pension drawdown. This is sometimes called phased or partial drawdown.

You can at any time use all or part of the money in your pension drawdown pot to buy a guaranteed income (an annuity) or other type of retirement income product that might meet your needs.

What’s available in the market will vary at any given time. So you might want to discuss your options with a financial adviser or book a Pension Wise appointment.

You need to carefully plan how much income you can afford to take under pension drawdown, otherwise there’s a risk you’ll run out of money.

This could happen if:

•  you live longer than you’ve planned for
•  you take out too much too soon
•  your investments don’t perform as well as you expect, and you don’t adjust the amount you take accordingly.

You can use our calculator below to help you think about how much income to take.

If you choose pension drawdown, you’ll need to decide how to invest your pension pot. And it’s important to regularly review your investments.  

Your provider will ask how you want to invest your remaining pot when you move into pension drawdown. You will either need to choose your own investments that match your attitude to risk and objectives for your money. Alternatively, some providers will offer you a choice from simple ready-made investment options which are linked to your retirement plans. These are called investment pathways. They can simplify the decision of how to invest your remaining pension pot after you’ve taken your tax-free lump sum.

You could also use a financial adviser to help you choose.

As with all investments, the value of your pot can go up or down.

It’s also important to understand what charges you need to pay, as they can deplete your pot. Charges vary between providers; some policies have various charges.

Deciding whether pension drawdown is the right option for you is complicated.

Not all pension schemes or providers offer pension drawdown. Even if yours does, it’s important to compare what else is on the market. This is because charges, the choice of funds, the support and flexibility they offer might vary from one provider to another.

Comparing products yourself can be difficult unless you’re an experienced investor.

If you’re looking for products that offer simple ready-made investment options, you can use our investment pathways comparison tool to help you shop around.

Or you might want to use a regulated financial adviser. Advisers will review your needs and circumstances and recommend the best way to use your pensions. This will include which products to use and how much income to take and when.

Any money you take from your pension drawdown pot above the tax-free lump sum will be taxed as earnings in the tax year you take it.

For example, you have a pot of £80,000 and take a tax-free lump sum of £20,000. This leaves you with £60,000 to invest. If you take an income of £3,000 a year from your pension pot and are a basic rate taxpayer, you’ll pay 20% tax and so you’ll get £2,400.

Be aware that if you make large withdrawals, they could push you into a higher tax band. You might be able to reduce the amount of tax you pay by spreading payments and/or moving your money into drawdown over a number of tax years.

If you take a lump sum instead of a regular income, your provider might deduct emergency tax from your payments.

Previously, if the value of your pension savings exceeded £1,073,100, a lifetime allowance charge might apply on any excess. For tax year 2024/25, this is being replaced with the lump sum allowance and lump sum and death benefit allowance.

If you choose to go into pension drawdown and draw an income, but are continuing to save into a pension, the amount you can pay into a defined contribution pension and still get tax relief reduces. This is known as the money purchase annual allowance or MPAA.  

If you’re planning to take your tax-free lump sum and make further contributions into a pension, you need to be aware of:

• The ‘pension recycling’ rules. These are designed to prevent people from getting further tax relief on contributions where they have already benefited from tax relief.
  
  You could be affected by the pension recycling rules if you plan to use some or all of your tax-free lump sum to significantly increase contributions to a pension.

• The MPAA. This limits the amount of contributions to a defined contribution pension pot that get tax relief to £10,000.

If you’re considering reinvesting your tax-free lump sum into a pension, consider speaking to a financial adviser. They can help you look at whether putting the money back into a pension is the best option for you and help you avoid any pitfalls.

If you’re planning to take your tax-free lump sum and pay that into the same pension pot or another one, you need to be aware of ‘pension recycling’ rules.

It could be pension recycling if you intend to use the tax-free lump sum to pay into a pension to get tax relief.

If HMRC decide you have broken pension recycling rules, you might have to pay tax on the whole of the original tax-free lump sum. This will be the case even if you only recycle some of the money.

If you’re considering reinvesting your tax-free money into a pension, it’s important to get financial advice.

Taking money from your pension may affect your eligibility for means-tested State benefits. 

A company or person that you owe money to cannot normally make a claim against your pensions if you haven't started taking money from them yet. This also applies to County Court Judgements and Individual Voluntary Arrangements. Once you've withdrawn money from your pension, however, you may be expected to pay.

If you need to clear debts, it’s important to get specialist help before accessing your pension.

You can nominate who you’d like to get any money left in your drawdown pot when you die:

• If you die before the age of 75, any money left in your drawdown fund passes tax-free to your nominated beneficiaries, if taken as income. From 6 April 2024, however, it’ll be subject to the lump sum and death benefits allowance (LSBDA), if they take it as a lump sum. Find out more in our guide Tax-free lump sum allowances for pension.
• The money must be paid within two years of the provider becoming aware of your death. If the two-year limit is missed, payments will be added to the income of the beneficiary and taxed as earnings.
• If you die after the age of 75 and your nominated beneficiary takes the money as income or a lump sum, the money will be added to their other income and taxed as earnings.

A beneficiary might be able to choose to continue drawing down from the pension pot, taking a one off lump sum or buying an annuity. Check what death benefits providers offer. 

At the moment, death benefits and unused pensions are not included as part of your estate for calculating Inheritance Tax. A change announced in the Autumn 2024 Budget means that these could be liable for Inheritance Tax from April 2027.

Which retirement option is best for you – or which combination of options – depends a lot on your situation, and what other sources of income you’re likely to have in retirement.

Speak to a financial adviser who’ll be able to give you advice based on your personal situation.

Before April 2015, the pension drawdown rules were different - you could take drawdown in one of two ways: either a capped or a flexible version.

These policies were available before April 2015. You might still have this type of policy.

The amount you can take as income is capped at 150% of the rate set by the Government Actuary Department (GAD). This is broadly based on the income a healthy person of the same age could get from a lifetime annuity.

It’s reviewed every three years if you’re under the age of 75, and yearly after this.

On the review date, a new maximum income is calculated – based on the revised fund size and latest GAD rates – and set for the next period.

If you set up a capped drawdown arrangement before April 2015:

• You can continue to use your capped drawdown arrangement in the same way. To remain being able to use it in the same way, you’ll need to keep your income within the cap. If you take income that exceeds the cap, you’ll moved into flexi-access drawdown.
• If you remain in capped drawdown, you won’t be affected by the reduced money purchase annual allowance (MPAA) of £10,000 and can continue to contribute up to £60,000 per annum.
• You can switch into a new drawdown policy, so you can draw more than the cap. Check if your provider allows this. If not, you could transfer to a new policy. The first withdrawal will trigger the MPAA, so contributions to a defined contribution pot that receive tax relief after this date will be limited to £10,000 each tax year.

This type of drawdown policy was available before April 2015.

It allowed you to make unlimited withdrawals from your pot if you had a guaranteed income of £12,000 a year (before tax). It wasn’t available to everyone to use in the same way that’s been available since April 2015.

Any flexible drawdown arrangement set up before April 2015 automatically converted to a flexi-access drawdown arrangement after April 2015. 

Income drawdown is just one of several options available to you for taking your pension.

For an overview of all your options, book a Pension Wise appointment.