So what is Flexible retirement income, also often referred to as pension drawdown or Flexi-access drawdown (FAD).
It is a way to control how much you take out of your Defined Contribution (DC pot. As a way to fund your income in retirement.
The aim is to give you flexibility over how you can access the funds invested within your pension pot.
Initially you can draw up to 25% tax-free upfront, which can be in 1 go or several different stages. The remaining funds are then invested, giving it the potential for future investment growth. Although there is a risk that it can go and down in value ahead of accessing.
Upon accessing the remaining funds you can decide if you want a regular income. Or ad-hoc lump sums and and when you needs such funds.
As the invested pot is not guaranteed you means that you could run out of money in future. It may well be in possibly 10, 15 or 20 years.
So how does Pension drawdown work ?
This will depend upon the arrangement with your current pension provider, some providers may not offer such option. Especially if you have an older scheme and you may only can buy an annuity. Thanks to Pensions Freedom being introduced in 2015. The way you can access a pension has completely been changed and gives people much more flexibility.
Even if your provider does offer FAD, you do have the ability to shop around to get the required product suitable for you.
It is often a good idea to check before transferring out. But do you lose any special features such as valuable guarantees or annual bonuses if it’s a with-profits policy.
As stated you can normally access up to 25% of the total pot value as a tax-free lump sum upfront. This can be done on initially accessing your pension pot via drawdown, or partially.
Unfortunately, any income you then withdraw whether on a regular of ad-hoc lump sum basis. Will then it be classed as taxable earnings.
This would normally be taxed at source by the pension provider and would be included with any other earnings within the UK tax-year.
Income tax bandings: (as per 2024/2025)
(England / Wales / Northern Ireland)
Tax-free personal allowance: £ 0 to £ 12,570 – 0%
Basic rate: £ 12,571 to £ 50,270 – 20%
Higher rate: £ 50,271 to £ 125,140 – 40%
Additional higher rate: £ 125,140+ – 45%
(Different tax bandings apply to people resident in Scotland)
It always advisable to consider what other earnings you have within the tax-year when drawing income from the pension. It may push you into a higher tax bracket for a particular year. Your provider may apply month 1 emergency tax when you make your 1st withdrawal.
But the good news is that most providers will tax at source and then rebalance at the end of the tax year. You can reclaim your tax back in a quicker timeframe through gov.uk.
However though you don’t have to complicate matters by completing self-assessment forms as your provider should do it automatically and will notify HMRC on your behalf.
With regard to the money still invested within the drawdown account, you will have to decide where you invest those funds.
This should match your attitude to risk and your tolerance to see the pot go up and down in future. Most people will see a headline figure for their pot value, but in the accumulation stage most people are invested into default or lifestyle funds.
It’s important to think about your investment choices, and how and when you may withdraw the funds. Remember the more money you take out in the early years the less time the pot will last. It then may run out much quicker than previously expected.
Most providers should have tools and calculators to assist you, so play around with the figures to look at illustrations.
You do have the option to move your pension funds gradually into drawdown, this can be called phased or partial drawdown.
Can I change my mind, once my pot is invested in a drawdown account ?
You can use all or some of your total pot to enter in FAD, but your circumstance could change.
A simple example, you could take the initial 25% as a tax-free lump sum and leave the rest invested. At a later date you could use the remaining funds to buy an annuity. Which could give you a guaranteed income for future years.
This will depend on what options you may choose at the specific time you make that decision. Somebody may want to change their mind to give them security, they may want to not make investment decisions. Or they could develop ill-health so be awarded an enhanced rate of income as they may be perceived as a greater risk to the pension provider.
How do I make investments for the remaining pension pot ?
You will have to decide how they make those decisions in future. It’s important to review your circumstances and investments on a regular basis.
There are normally 2 ways of controlling your investments.
- Your pension provider will ask you where and how you wish to invest the funds yourself, and you can then choose such investments that match your risk profile. Are you happy and comfortable making your own investment decisions.
- Or you can choose a simple ready-made option called “Investment Pathways” and you choose 1 of the 4 pathways linked to how to access over the next 5 years.
The 4 Investment pathways options –
- You plan no plans to access the funds within 5 years.
- The plan is to draw a regular income within 5 years.
- I plan to start drawing a long term income within 5 years
- I intend to withdraw all of the money within the next 5 years
If you are not happy making your own decisions, you could use the help of a regulated financial adviser to assist you. But this will cost you, so it may be worthwhile to approach 2 to 3 as a beauty parade to see what products, service or value they offer you.
If you do use an adviser to help you, could you take advantage of the Pensions Advice Allowance to meet such costs. You can take £ 500 each year tax-free from a pension pot to pay towards the cost of financial advice. (so £ 1,500 in total)
It may not be offered by all providers, it may not be worthwhile if you have a small pot, or may not meet the total costs. However though, most people don’t know that it exists, so may be put off using an adviser to assist.
What about fees and charges and conditions of access ?
Most providers are charging you fees at present whilst you are in the accumulation stage. This will also apply once you put it into drawdown.
- So check what fees apply, is it a set fee or a % of your total funds, and will the funds be reduced over time as your pot decreases in value.
- What are the restrictions for taking a monthly income, it may be £ 100 as a minimum amount each month ?
- What about taking lump sums, is it say a minimum of £ 1,000 per withdrawal ?
- Is there a restriction on the number of lump sums each year, some providers may say 3, some may say 5 and is there a fee each time you make a withdrawal.
How can I shop around ?
The idea of shopping around can be daunting for some people, and many people suffer from inertia. They may say that I have been with small provider for many years, so will stay with them for ease.
It is important to compare other providers and see what products they offer you, you may even stay with the same provider. But at least spend some time shopping around and comparing products.
This is because fees, investment options, choices of funds, and restrictions of access will differ from provider to provider. So ideally you want the product that works best for you.
The following link is helpful via the Moneyhelper.org.uk website:
investment pathways comparison tool
Or to find yourself a regulated Financial adviser:
Can I still contribute to my DC pension once I access funds ?
If you only take the tax-free lump sum if is not normally a problem or consideration.
Once you draw a flexible income after the tax-free cash you will trigger something called the Money Purchase Annual Allowance (MPAA). Your pension contributions into a DC pensioner restricted to £ 10,000 per year for tax-relief purposes. This will be triggered straight away when taking the 1st flexible income payment.
If you trigger this event a provider will give you a statement or certificate and you are normally required to give that form to a current pension provider within 91 days.
Or it may result in a small tax charge, for most people it’s not an issue as they are below that threshold level of contributions, it’s a simple admin procedure.
If you do take the tax-free cash invest that money into the bank, building society or other form of assets or investments.
If you use that to top up another pension scheme it could be considered as pension recycling, so be aware of pension recycling rules.
In the event that HMRC see fit that you have broken pension recycling rules, you may have to pay tax on the whole or the original tax-free lump sum. (see attached link for specific guidance)
https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm133810
What about the death benefits ?
You can nominate family members, such a spouse or children as potential beneficiaries to inherit any funds left in the drawdown pot in the event of your death.
- If you die before age 75: any money left in the pot can pass to beneficiaries tax-free as income or lump-sum payment. As long as they act within a 2-year period and tell the pension of their future intentions. If they fail to act within the 2-year window, the payments will then be subject to income tax at the beneficiaries marginal rate.
- If you die after age 75: and the beneficiary accesses the money as lump sum or income it will be classed as taxable income. Which will then be added to any other they have within that respective tax year.
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