Pension drawdown explained: how it works and how long it lasts

How drawdown works

Pension drawdown, also called flexi-access drawdown, is one way to take money from a defined contribution pension. Instead of swapping your pot for a guaranteed income (an annuity), you leave it invested and take money out as and when you choose.

1. You move some or all of your pot into drawdown. You can usually take up to 25% of what you move as a tax-free lump sum at that point.
2. The rest stays invested. It can grow, or fall, with the markets.
3. You take income when you want. A regular monthly amount, occasional lump sums, or nothing for a while. Every withdrawal after the tax-free part is taxed as income.

You can do this in stages: move a slice into drawdown each year, taking the tax-free part of each slice. Our guide to the tax-free lump sum compares the options.

How long will the money last?

That depends on how much you take, how your investments grow and how long you live. Here is a £300,000 pot, with withdrawals starting at the rates shown and rising by 2.5% a year to keep up with inflation:

Someone retiring at 66 today has a fair chance of living into their late eighties or nineties. That is why UK research suggests starting lower than 5%: about 3.7–3.9% a year before fees according to Rathbones, and nearer 2.5–3% for people paying around 1% in fees according to Morningstar. Try your own numbers with the drawdown calculator.

The risk most people miss: bad years early on

When you are taking money out, the order of returns matters, not just the average. This is called "sequence risk".

Take the same £300,000 pot, taking £15,000 a year. Over ten years the investments have exactly the same returns, including a 20% fall and a 10% fall. Only the order is different:

A fall early in retirement does more damage because you are selling investments while they are cheap to pay your income. Some ways people reduce this risk:

• keeping one to two years of withdrawals in cash, so you don't have to sell after a fall;
• taking less in years when markets have fallen;
• using part of the pot to buy an annuity that covers essential bills.

Tax on drawdown

• Withdrawals above the tax-free part are added to your other income, including the State Pension, and taxed at your usual rates.
• The first withdrawal is often taxed on an emergency basis. You can claim the excess back from HMRC.
• Taking taxable money from drawdown triggers the money purchase annual allowance: from then on, you can usually pay only £10,000 a year into defined contribution pensions with tax relief.
• Keeping each year's withdrawals within your basic-rate band can save a lot of tax compared with large one-off withdrawals.

Drawdown or an annuity?

Many people combine the two: an annuity, plus the State Pension, to cover essential bills, and drawdown for the rest. Annuity rates change often, so compare quotes from several providers if you go that way.

Before you start

1. Book a free Pension Wise appointment if you are 50 or over.
2. Compare the total cost: the provider's drawdown or platform charge plus your fund charges. Small differences add up over 25 years.
3. Check your old pensions for valuable guarantees, such as a guaranteed annuity rate, before moving them.
4. Decide how much you need each year, and check it against the retirement budgets.

This guide is general information, not personal financial advice. Rules can change and your situation may differ. For free, impartial help, contact MoneyHelper, or speak to a regulated financial adviser.