Using pension withdrawals as income is known as Drawdown. This is available from age 55 onwards, however it is due to increase for most people on 6th April 2028 to age 57. In this article, we’ll explore the drawdown options available, how to use this as an income in retirement and the tax implications for making withdrawals.
How you withdraw from your pension is an important decision. To help make your pension last throughout your retirement, it could be worth considering whether you’d like to make regular or one off withdrawals, how this will impact your remaining pension and if your withdrawals could take too much out of your pension pot.
With those key considerations in mind, here are the five most common pension withdrawal options:
Flexi-access drawdown
This is a way of withdrawing from your pension that enables you to take some money whilst leaving the rest invested. You can normally take up to 25% of the value of the portion of pension you’re accessing as tax-free cash in one lump sum or in portions over time, leaving the rest of that portion invested in a drawdown plan to be accessed in the future either as regular payments or further lump sums. However, you do not need to take the full 25% tax-free cash and you can leave the remaining invested for future use.
Any portion of your remaining pension pot not assigned into a drawdown plan remains ‘uncrystallised’ – this means it has not been accessed for pension purposes.
As an example, for every £1 accessed tax-free, £3 will be moved into a drawdown plan to be used later. These amounts are considered ‘crystallised’ or accessed for pension purposes.
Uncrystallised Fund Pension Lump Sum (UFPLS)
An UFPLS is a flexible way to take money from your pension. Rather than assigning all (or a portion) of your pension into a drawdown plan, an uncrystallised fund pension lump sum allows you to make lump sum withdrawals of which 25% is tax-free and the rest taxed as income at your marginal rate. Your marginal tax rate is based on your tax bracket. Most people in the UK receive a Personal Allowance of £12,570, which means they can earn up to this amount tax-free. Following that, there is a basic rate of 20% tax on income up to £50,270, a higher rate of 40% up to £125,140 and an additional rate of 45% on income over £125,140.
Anything you don’t withdraw remains invested according to the rules of your pension scheme, and no part of your pension is assigned to a drawdown plan.
For example, if you would like to withdraw a £5,000 lump sum from your pension pot as UFPLS, £1,250 would be tax-free and the other £3,750 would be taxed at your marginal rate. This option differs from a flexi-access drawdown, as rather than a portion of your pension being assigned into a drawdown plan (and therefore considered ‘accessed’ for pension purposes), an uncrystallised fund pension lump sum is made of one-off payments that leaves the rest of your pension ‘uncrystallised’ or not accessed for pension purposes.
Small pots
There are rules that allow you to cash in a small pension pot of £10,000 or less, if you’ve reached age 55 (57 in 2028) and the payment covers all your rights in the scheme.
You must take the whole pension pot at one time and this will close the pension following the withdrawal.
Approximately 25% of the withdrawal will be tax-free and the other 75% of the withdrawal will be taxed at your marginal income tax rate. You can receive up to three small pots payments but these must be from three different pension pots. For example, if your pension pot is £10,000 you must take this as a one off lump sum. £2,500 will be tax-free and the other £7,500 will be taxed at your income tax rate.
Existing capped drawdown
Existing capped drawdown is only available to those that chose this option before 2015 or are currently in a capped drawdown plan. This is similar to flexi-access drawdown as you can take up to 25% of your pension pot as tax-free cash and use the rest as regular withdrawals to use as income. This income is taxable and can rise or fall depending on the fund’s performance.
However, to keep your capped drawdown status, you can only withdraw to a maximum limit set by the government. This is reviewed every three years if you’re under age 75 and annually after this5.
Annuities
You can use some or all of your pension fund to purchase an annuity at any time. Annuities are insurance policies that are bought with money from your pension pot that provide a guaranteed regular income for the rest of your life, no matter how long that is.
You have the option of monthly or yearly payments and some policies will allow you to protect between 25% and 100% of the money spent on the annuity when it was bought. This can be paid as a lump sum to a beneficiary when you pass away, usually minus any money already paid to you through the regular payments. Although you would receive a guaranteed income, annuities can lack flexibility if your circumstances change in the future. It’s important to note that True Potential does not offer annuities.
There are both benefits and disadvantages when it comes to withdrawing from your pension and some options may be more suited to your personal circumstances than others, therefore you should consult a financial adviser to help you consider all the options available.
With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. This material is not a personal recommendation or financial advice and the investments referred to may not be suitable for all investors.
Past performance is not a guide to future performance.
Pension eligibility and tax rules apply. You should ensure your contribution does not result in your total Pension contribution within the tax year exceeding £60,000 or 100% of your earnings, whichever is lower.
Tax is subject to an individual’s personal circumstances, and tax rules can change at any time. This article is not personal financial advice.
True Potential Wealth Management is authorised and regulated by the Financial Conduct Authority. FRN 529810. Registered in England and Wales as a Limited Liability Partnership No. OC356611.
True Potential Investments LLP is authorised and regulated by the Financial Conduct Authority. FRN 527444. Registered in England and Wales as a Limited Liability Partnership No. OC356027.
True Potential LLP is registered in England and Wales as a Limited Liability Partnership No. OC380771.
