Should you use flexible drawdown in retirement?

More people are accessing their pension pots using something called “flexible drawdown”. Despite growing in popularity, there’s still some confusion around when and how to use it, and the longer-term impact it can have on your pension pot and retirement plans.

What is flexible drawdown?

Flexible drawdown, or flexi-access drawdown as it is sometimes referred, is a way of taking money out of your pension pot to help fund your retirement.

Once you turn 55, 25% of your pension pot can be withdrawn as a tax-free lump sum, known as a Pension Commencement Lump Sum (PCLS).

Using flexible drawdown (through a wealth manager such as Nutmeg) allows you to control if, how, and when you take a PCLS, and how to take a regular income from your pension pot in retirement. Alternatively, you may prefer to request ad-hoc withdrawals as and when money is needed.

As you near retirement, it is prudent to understand the different options available to you through your existing provider, and any potential charges that may be incurred by accessing your pension.

Options vary across providers, and some may charge you a fee to start drawdown.

Nutmeg does not charge to commence drawdown from your pension pot and will offer you a free call with one of our experts to help you understand your options. For a fee, our restricted financial planning service can help with an individual’s retirement plan.

What do I need to consider when looking to access my pension using flexible drawdown?

There are a few primary considerations to think about when deciding to take flexible drawdown. It is not always the right choice for every individual.

1. How much should you take?

Perhaps the biggest challenge you face when deciding to access your pension pot using flexible drawdown is how much money to take from your pension pot.

Unlike an annuity or final-salary pension, which guarantees you a set income for life or for a stated number of years, accessing your pension using flexible drawdown offers no such guarantees. If not managed well, your pension pot may run out when you’re still reliant on the funds.

There is no hard-and-fast rule about how much you should take from your pension pot as this is dependent on your personal circumstances. You may have heard of the ‘4% rule’ which is sometimes discussed in the pension world as the optimal drawdown rate for your pension, however, as retirement is highly personal, this is unlikely to be suitable for everyone.

When deciding how much to take from your pension pot, it’s important to think about how long you may live in retirement, and the lifestyle or care needs you may have. For example, some people may use their personal pension as a bridging pension until their state pension commences, therefore not everyone is reliant on their personal pension for their whole retirement.

Although it can appear sensible to ‘de-risk’ your pension investments in retirement, it is also worth thinking about your overall drawdown strategy. Being too aggressive or even being conservative with your funds could be detrimental to your retirement plans in the long term.

2. What income do you require to live comfortably?

Understanding more about your regular income needs in retirement, will help you take withdrawals from your pension at a safe and sustainable rate.

3. What other expenses or outgoings do you have?

For some people, their primary source of income in retirement comes from other sources, such as a rental property. In such cases it is common for people to use their pension pot to top-up their income for expenses as-and-when they come up.

4. Your tax liability

Understanding any potential tax implications of your drawdown strategy is vital to ensure you’re maximising tax efficiency where possible.

Beyond the 25% achieved through PCLS, any further withdrawals are potentially taxable. Whether you incur tax on any further withdrawals will depend on your income for that tax year.

If you have no other income, then you may be able to utilise your personal allowance (£12,570 for the 22/23 tax year) to avoid incurring a tax liability. After this point any withdrawals outside of your tax-free lump sum will incur tax at either the basic rate, higher rate or additional rate tax band depending on your personal circumstances.

Your taxable income commonly includes your salary if you’re still working, any rental or taxable investment income you receive, your state pension, and any income from final salary pensions which have already commenced. Understanding any potential tax implications of your drawdown strategy is vital to ensure you’re maximising tax efficiency where possible.

A lesser-known fact about personal pensions is that they sit outside of your estate for Inheritance Tax purposes. This means your Nutmeg personal pension is not typically exposed to inheritance tax like other funds within your estate such as your property, other investments, and cash might be. Therefore, if you’re concerned about inheritance tax and have a reasonably large estate, preserving your pension pot as a tax efficient vehicle to pass on your wealth to your loved ones may be an option worth exploring.

Although pension funds are not usually subject to inheritance tax, in the unfortunate event you pass away, they may be subject to income tax at your beneficiary’s marginal tax rate depending on your age when you die.

5. What impact will inflation have on my pension?

Everyone’s drawdown strategy will be different, however, if you’re planning to use flexible drawdown to support you throughout the duration of your retirement – which may well be 20 or 30 plus years – then it is also important that you consider the impact of inflation on your pension provision over the longer term.

You will be relying, to some extent, on the portion of your pot that’s still invested to beat the rate of inflation over time. As with all investing, this is not guaranteed, though money invested still has more potential to grow than money withdrawn.

Regulatory considerations

There are also regulatory factors to consider when accessing your pension pot.

Did you know that when you access income from your pension you will trigger the Money Purchase Annual Allowance or MPAA rules? This irreversibly impacts the amount you can pay into defined contribution pensions, to a total of £4,000 per year.

This is particularly important if you’re still working and contributing to a pension. It’s important to highlight that the MPAA rules are only triggered when you access ‘income’ from you pension, this is the potentially taxable element of your pension pot. Accessing just the PCLS will not trigger the MPAA rules so could be an advantageous option if you’re still working and paying into your pensions.

Pension pots are also subject to a lifetime allowance test. For the 22/23 tax year, this is £1,073,100. Your options can be quite complex, however Holly Graham, a financial planner at Nutmeg, has published an article and video on how the lifetime allowance works, which can be accessed via the link below.

How Nutmeg can help

As we’ve explored, there are several important factors you must consider as you start thinking about accessing your pension pot.

Designing an investment and drawdown plan which aligns with your goals and objectives is important, and our team of qualified and experienced wealth managers would be happy to discuss your options with you.

Book a free call to speak to the team to understand your options. After this call, if you choose, our paid for, restricted financial planning service can help create a retirement plan that’s right for you.

Risk warning  

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. A pension may not be right for everyone and tax rules may change in the future. If you are unsure if a pension is right for you, please seek financial advice. Tax treatment depends on your individual circumstances and may be subject to change in the future.