Income Drawdown

You designate some or all of your pension into a flexi-access drawdown arrangement. Up to 25 per cent of the amount you crystallise can normally be paid as tax-free cash, subject to the lump sum allowance of £268,275 unless you hold protection. The remainder stays invested and you draw taxable income from it whenever you choose.

You can take nothing for a few years, take a regular monthly amount, take an ad hoc lump sum for a new car, or stop and start. Nothing obliges you to take a set figure. That freedom is genuinely useful for people with variable spending, and it is also how people run out of money early.

Taxable drawdown income is added to your other income for the year and taxed at your marginal rate. For most of the UK that means nothing on the first £12,570 if you have no other income, 20 per cent up to £50,270, 40 per cent above that, and 45 per cent above £125,140. Scottish rates and bands differ.

Two things regularly cost people money.

• A large withdrawal can push you into a higher band for that tax year. Splitting the same amount across two tax years often costs materially less.
• Your first withdrawal is usually taxed on an emergency month one basis, which assumes you will take that amount every month. People frequently get taxed several thousand pounds too much and have to reclaim it from HMRC using form P55, P53Z or P50Z, or wait for it to be sorted out at the end of the tax year.

The moment you take taxable income from drawdown, the money purchase annual allowance applies. From then on you can only put £10,000 a year into money purchase pensions and you cannot use carry forward. If you are still working and still contributing, that is a significant restriction.

Taking only your tax-free cash and leaving the rest untouched does not normally trigger it. So does taking a small pot lump sum from a personal pension worth £10,000 or less, which is a useful piece of housekeeping for people with odd fragments left over from old jobs. Sequencing this properly is one of the more valuable things advice does.

There is no safe rate that applies to everyone. What matters is your pot size, your other income, how long you need the money to last, and what the market does in your first few years of withdrawals.

That last one is the risk people underestimate. If markets fall early in retirement while you are taking income, you are selling units at low prices and there is less left to recover when things improve. Two people with identical pots and identical withdrawal rates can end up in very different places purely because of the order in which returns arrived. Holding a cash buffer of a year or two of income, so you are not forced to sell after a fall, is one straightforward way of managing it.

We model your income against your actual spending, revisit it at least annually, and adjust when circumstances or markets change. A drawdown plan set once and never reviewed is not a plan.

Anything left in drawdown can pass to your beneficiaries. If you die before 75 it can generally be taken by them free of income tax, subject to the lump sum and death benefit allowance. If you die after 75 they pay income tax at their own marginal rate on what they take.

The rules on inheritance tax are changing. From April 2027 unused pension funds are expected to be brought within the value of your estate for inheritance tax purposes. If your plan relies on the pension passing on outside your estate, it is worth revisiting well before then rather than after.

If you need certainty and your essential outgoings would be hard to cover from a fluctuating income, an annuity may do a better job for at least part of the pot. Some people cover the fixed bills with secure income from the state pension and an annuity, and use drawdown for everything else. Blending the two is common and often sensible.

Heritage is independent and directly authorised by the Financial Conduct Authority, firm reference 624976. We advise from our office in Taunton and see clients across Somerset and the South West.