- Drawdown is one way to take an income from your pension pot from age 55.
- You draw an income directly from your pension pot while it remains invested.
- Your pot has the opportunity to benefit from further potential investment growth while you take an income.
- You can choose how your money is invested in a range of funds, shares and bonds. Read more about investment options for drawdown in our guide: [how to set up drawdown]
- New rules that apply from April 2015 have made it much easier to draw down as much or as little as you like once you reach the age of 55.
- You can take (or “draw down”) a regular income, for example monthly or annually, the occasional lump sum, or a combination, whatever suits you.
- In the majority of situations when you die both crystallised and uncrystallised pension funds will not be subject to inheritance tax .
When you retire you can usually take up to 25% of your pension pot tax-free. Any further withdrawals are subject to your marginal UK Income Tax rate.
There are two options available for pensioners looking to make withdrawals (or drawdown) directly from their invested funds.
- Uncrystallised Fund Pension Lump Sums (UFPLS)
Taking a UFPLS
You can take a lump sum or series of lump sums directly from your pension, normally with 25% of each lump sum tax-free. The remainder of the lump sum will be subject to your marginal rate of UK Income Tax .
“Uncrystallised” refers to a portion of your pension pot that has not had a tax-free lump-sum taken from it and is not providing you with an income.
You can take your entire pension pot as a UPFLS withdrawal, or you can take a series of smaller withdrawals leaving the remainder untouched for withdrawal at a later date, to go into flexi-access drawdown with, or to purchase an annuity.
UFPLS withdrawals can be useful if you don’t want to take the whole of your 25% tax-free portion of your pension pot all at once.
If you take any UFPLS this will trigger the Money Purchase Annual Allowance (MPAA). This means that the annual allowance that you can contribute to pension schemes and receive tax relief on is reduced to £10,000 per year.
When you opt for flexi-access drawdown you can take up to 25% of your whole pension pot as a tax-free lump sum, and then draw an income from your pension pot which will be taxed at your marginal rate.
“Flexi-access” means that once you’ve taken your tax-free lump sum you’re free to withdraw as much
or as little income from your pension pot, whenever you want.
If you take any taxable income via flexi-access drawdown this will trigger the MPAA and your annual allowance will be reduced to £10,000.
If you only take the tax free cash without taking any taxable income this will not trigger the MPAA and you will retain an annual allowance of £40,000.
Drawdown vs. annuity
An annuity offers a regular income in return for an upfront lump-sum payment. The income is usually, though not always, guaranteed until you die.
You can read more about how annuities work by reading our guide: what is an annuity .
Drawdown offers greater flexibility than an annuity, but less security.
- If you opt for drawdown there’s a chance that you could run out of money before you die, for example if you spend your money too quickly or if you live longer than expected. An annuity income is usually guaranteed until you die.
- Annuity rates are relatively low at the moment so you might get less out of your pension pot overall.
- Drawdown offers the chance to leave your pension pot invested so it can benefit from further potential growth, but get your investment decisions wrong and your pot could diminish in value.
- Once you’ve purchased an annuity you can’t go back on your decision, drawdown gives you greater flexibility over how and when you take an income, and you can change your plan to suit your changing needs.
- Any pension funds that remain invested in a pension wrapper when you die can usually be passed on to your beneficiaries Inheritance Tax free.
Combining your options
You can generate an income for retirement using a variety of options, not just one.
James has £200,000 in his pension pot and decides to take a £10,000 lump sum as an UFPLS withdrawal, he’ll takes £2,500 (25% of £10,000) as a tax-free lump-sum. The remainder of the lump sum, £7,500 is subject to James’ marginal rate of income tax.
James will then have £190,000 remaining in his pension fund, “uncrystallised”, or, in other words, untouched.
James later decides to use £100,000 of his remaining £190,000. He takes 25% of this amount as a tax-free lump sum, that’s £25,000, and uses £75,000 to purchase an annuity income which is taxable at his marginal rate.
James leaves the remaining £90,000 uncrystallised and plans to take flexi-access drawdown later on in retirement to support his annuity income.
For practical steps to setting up drawdown, more on drawdown investment options, and how to choose a pension wrapper, read our guide: how to set up drawdown.