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Pension Drawdown Explained

Retirement 6 min readGuide 18
Pension Drawdown Explained

Pension drawdown lets you keep your pension pot invested and draw an income as needed. This guide explains how drawdown works, the risks involved and how to manage it effectively in retirement.

Quick answer

Pension drawdown lets you keep your pension pot invested and draw an income as and when you need it. You have complete flexibility over how much you take and when, but the income is not guaranteed and the pot can run out if you draw too much or investments perform poorly. It requires ongoing management and, ideally, financial advice.

How drawdown works

When you enter drawdown, your pension pot remains invested. You can take withdrawals as and when you need them, a regular monthly income, irregular lump sums or a combination. There is no limit on how much you can take, but all withdrawals (except the tax-free cash element) are subject to income tax.

To enter drawdown, you first designate your pension pot (or part of it) to a drawdown arrangement. At this point, you can take up to 25% of the designated amount as a tax-free lump sum. The remaining 75% moves into the drawdown fund and remains invested.

You can choose how your drawdown pot is invested, typically from a range of funds offered by your provider. The investment strategy in drawdown may be different from your pre-retirement strategy, as you need to balance growth with the need to fund withdrawals.

The risks of drawdown

Drawdown involves several risks that do not exist with an annuity:

Longevity risk, the risk of outliving your savings. If you live longer than expected and draw a regular income, your pot could run out. This is the most fundamental risk of drawdown.

Investment risk, the value of your drawdown pot can fall as well as rise. Poor investment performance reduces the pot and the income it can support.

Sequencing risk, poor investment returns early in retirement, combined with regular withdrawals, can permanently deplete a drawdown pot in a way that is very difficult to recover from. This is because withdrawals during a downturn lock in losses and reduce the pot available to benefit from any subsequent recovery.

Behavioural risk, the temptation to take too much too soon, or to make poor investment decisions in response to market volatility.

Steve

Steve's observation

Drawdown is a powerful tool, but it requires discipline and ongoing management. I have seen clients enter drawdown with a clear plan and stick to it successfully for 20 years. I have also seen clients who drew too much in the early years and found themselves in difficulty later.

The key is to have a plan, a clear view of how much you need to draw each year, what investment strategy you are following and what you will do if markets fall significantly. Without a plan, drawdown can become a slow erosion of your retirement savings.

This is an area where ongoing financial advice genuinely earns its cost. A good adviser will help you set a sustainable withdrawal rate, manage your investment strategy and adjust your plan as your circumstances change.

Managing your drawdown pot

Effective drawdown management involves several ongoing tasks:

  • Setting a sustainable withdrawal rate and reviewing it regularly
  • Choosing an appropriate investment strategy for your drawdown pot
  • Rebalancing your investments periodically to maintain your target allocation
  • Monitoring your pot value and adjusting withdrawals if needed
  • Managing the tax implications of withdrawals across tax years
  • Reviewing your plan when your circumstances change

Sustainable withdrawal rates

A sustainable withdrawal rate is the percentage of your drawdown pot you can withdraw each year without depleting it over a given time period. Research suggests that a withdrawal rate of around 3–4% per year is broadly sustainable over a 30-year retirement, assuming a balanced investment portfolio, though this is a guide, not a guarantee.

The appropriate withdrawal rate for you depends on your pot size, your other income, your expenditure needs, your investment strategy and your life expectancy. A financial adviser can help you model different scenarios and set a withdrawal rate that is appropriate for your circumstances.

Death benefits in drawdown

One of the significant advantages of drawdown over an annuity is the death benefit. If you die before age 75, your drawdown pot can usually be passed on to your beneficiaries free of income tax (though it may be subject to inheritance tax in some circumstances). If you die after 75, withdrawals by beneficiaries are subject to income tax at their marginal rate.

Make sure your expression of wishes is up to date with your pension provider, nominating who you would like to receive your drawdown pot. This is not legally binding but is taken seriously by providers and trustees.

Drawdown vs annuity

The choice between drawdown and an annuity is not binary, many people use a combination of both. A common approach is to use part of the pension pot to buy an annuity that covers essential expenditure (providing a guaranteed income floor), and keep the rest in drawdown for discretionary spending and flexibility.

The right balance depends on your circumstances, health, other income sources and attitude to risk. This is one of the most important financial decisions most people will make, and taking regulated financial advice is strongly recommended.

Pause for thought

  • Have you considered how much income you need from your pension each year in retirement?
  • Do you understand the risks of drawdown, particularly longevity risk and sequencing risk?
  • Have you thought about what investment strategy you would use in drawdown?
  • Is your expression of wishes up to date, nominating who should receive your drawdown pot if you die?

Coaching point

Before entering drawdown, write down your annual income needs in retirement and compare this to your expected income from all sources, state pension, other pensions, savings and investments. The gap between your needs and your guaranteed income is what your drawdown pot needs to fill. This gives you a clear starting point for planning your withdrawal strategy.

Key terms

Flexi-access drawdownA pension arrangement where your pot remains invested and you can draw an income as needed, with no limit on withdrawals.
Longevity riskThe risk of outliving your pension savings, a key concern with drawdown arrangements.
Sequencing riskThe risk that poor investment returns early in retirement, combined with withdrawals, can permanently deplete a drawdown pot.
Sustainable withdrawal rateThe percentage of your drawdown pot you can withdraw each year without depleting it over a given time period.
Death benefitsThe pension benefits payable to your beneficiaries when you die. Drawdown pots can usually be passed on to beneficiaries.
MPAAMoney purchase annual allowance, the reduced annual allowance (£10,000) that applies once you have taken flexible income from a drawdown arrangement.

Frequently asked questions

What to do next

If you are approaching retirement and considering drawdown, think carefully about your income needs, your risk tolerance and whether you have the knowledge and discipline to manage a drawdown arrangement effectively. Taking regulated financial advice is strongly recommended.

Guide 19 covers what happens when your employer changes pension provider, a situation that affects many workplace pension members.

This guide provides general information only and does not constitute personal financial, pension, investment or tax advice. The value of investments can go down as well as up and you may get back less than you invest. Drawdown income is not guaranteed and your pot can run out. Appropriate regulated financial advice is strongly recommended before entering drawdown.
Taking a Lump Sum From Your PensionMy Employer Has Changed Pension Provider