Is a Pension Drawdown a Good Idea?
Lots of people we speak to who are considering equity release also wonder whether opting for a pension drawdown is a good idea or not.
This is because more and more people over the age of 55 are struggling for cash, with the majority of their wealth being tied up in equity such as property.
Whether you are pulling out the woolly jumpers over the winter months to save on heating and energy bills or simply switching to a cheaper car – more and more people are finding ways to free up more cash. For a lot of people across the UK, this is where a pension drawdown plan comes in.
For a lot of people, retirement planning is one of life’s big financial decisions. This is why it is worth understanding the ins and outs of features such as a pension drawdown plan, so that you understand the benefits and pitfalls, and whether it might suit your plans for the future.
What Exactly Is Pension Drawdown?
In simple terms, a pension drawdown is a way of taking money from your pension pot. Once you reach the minimum pension age, which currently sits at 55 (rising to 57 from April 2028) you can withdraw funds from your defined contribution pension and leave the rest invested in your pension pot [1].
A pension drawdown plan is a flexible alternative to locking your pension into a fixed income, and it also gives you the freedom to choose how much and how often you take money out of your pension pot.
Under UK rules, you are able to withdraw up to 25% of your pension pot, entirely tax free. You can take this out in one large lump sum, or through a number of smaller payments. The remaining 75% is taxable as income when you do withdraw it, just as any other form of income would be [1].
What are the Advantages to Opting for a Pension Drawdown?
Tens of thousands of people up and down the country are considering taking out a drawdown plan from their pension. In fact, recent data has shown a surge in drawdown arrangements as retirees look for tax-free, flexible income. There are a number of different reasons why people are considering a pension drawdown plan, some of which are listed below for you.
1. It Offers Flexibility
One of the biggest advantages to a pension drawdown plan is the flexibility that it offers. For example, a pension drawdown plan lets you choose how much you withdraw and when. You are also free to spend the money on whatever you want, including a family holiday, a new car or home renovations. You are also free to give the money to loved ones to help them with the cost of living, university fees or house deposits.
2. Investment Potential
With a pension drawdown plan, some of your pension remains invested, meaning that there is a chance it will continue to grow over time as you continue your retirement. If markets perform well, that can help sustain your income for longer, which is ideal if you’re planning for a long and happy retirement.
3. Tax Saving Opportunities
You should always speak to a financial adviser about how best to navigate how much tax you have to pay on your pension income. By timing your withdrawals just right, you can manage how much income tax you pay each year.
For example, smaller withdrawals might mean you stay in a lower tax bracket. However, lump sums might be more tax efficient in years to come, when your income might be lower.
What Are the Disadvantages to opting for a Pension Drawdown?
When considering any type of mortgage, loan or drawdown plan, it is always worth understanding the risks before you opt in. Below are just some of the disadvantages linked to a pension drawdown plan [2].
1. It is Not Guaranteed Income
A pension drawdown plan does not guarantee you a set yearly income for the rest of your life. As with most types of investments, your retirement income can fluctuate with market conditions. For example, if investments are performing badly then the value of your pension pot and the income it can generate may fall [3].
2. Potential to Run Out of Money
Because you control how much you withdraw with a pension drawdown plan, there’s a real risk of depleting your pension too quickly. This is especially the case if you take large sums early on, or if the markets do not work in your favour.
3. Tax and Other Changes
Unfortunately, the rules surrounding pensions are always changing. For example, as of April 2027, unspent pensions, including funds in a drawdown account, are said to be being charged inheritance tax.
That might make drawdown less attractive if one of your goals is passing wealth on to your loved ones is something important to you.
Who Should Consider a Drawdown Pension?
A drawdown pension is not the right choice for everyone, so it is important to carefully consider why a drawdown pension plan might be the best option for you, and whether any alternative options are also available.
A drawdown pension might be the right option for you if you are comfortable with investment risk and understand that the markets might not always work in your favour.
Likewise, you might also be the right fit for a drawdown pension if you have a good grasp on exactly how tax affects your income.
It’s always worth speaking to a professional about this if you are unsure. Likewise, you might also be right for a drawdown pension if you want the flexibility in how much you get access to and how you want to spend it.
However, a pension drawdown plan might be less suitable for those who value a guaranteed lifelong income, prefer simplicity over active involvement and are likely to need a fixed monthly budget during their retirement.
Practical Tips Before You Choose a Pension Drawdown Plan
If you’re seriously considering opting for a pension drawdown plan, then below are some tips and tricks that you should consider.
1. Do the Numbers and Forecasting
If you are considering taking out a drawdown plan from your pension, then it is important that you do the numbers first before committing.
You should model different scenarios based on your income needs, the implications on tax and the potential market returns of your investments within your pension. You should seek the help and advice of a financial planner in order to do so.
2. Regularly Review the Situation
You should frequently be checking in on your investments and on your pension pot. You should aim to check in at least once a year or once every six months to make sure that your pension pot is safe and is doing well, especially if you have opted for a drawdown plan.
3. Seek Professional Advice
If you are considering a pension drawdown plan, then you should seek the advice and support of a financial adviser.
A good, regulated financial adviser can help with your investment options, your tax planning and making sure your drawdown strategy fits your wider retirement and life goals.
It is always important to be open and honest with your financial adviser about your current circumstances, your income, your investments and your wider financial goals.
Conclusion
As discussed at the very start of this article, tens of thousands of people up and down the country are currently considering a pension drawdown.
Whilst this might be the best option for the majority, it is always important to seek the advice of a qualified financial advisor first to make sure that drawing down from your pension is the right decision for you and your current and future circumstances.
There are many benefits associated with opting for a drawdown pension plan, including increased flexibility and potential for growth.
However, it is important that your risk appetite is comfortable with the associated risk that comes with opting for a drawdown plan.
It is important to remember and to acknowledge that retirement isn’t just about stretching your pension pot and pension income as far as it will go for as long as it can.
Instead, it’s about enjoying the money you have worked hard to save for this time in your life.
For more advice and support on whether you should opt for a drawdown pension plan, speak to our team at Equity Release Warehouse by calling us for free on 0330 058 1579 or by visiting us online by searching for www.equityreleasewarehouse.com.
References
[2] https://www.ftadviser.com/content/25d4550b-e079-5ca5-a378-30a73e437e2e
[3] https://www.hsbc.co.uk/retirement/what-is-a-drawdown-pension/
