When the rules on pensions were overhauled in 2015, the government scrapped the compulsion for people to buy an annuity, which provided an income for life, and allowed everybody to make withdrawals directly from their pension funds from the age of 55.
Accessing your pension in this way is known as pension drawdown, and while it offers enormous flexibility, it also presents those in their fifties with one of the biggest financial decisions of their lives - with a myriad of different options to choose from.
Deciding if, when and how we access our pension pot, and what we do with the proceeds, is a complicated process, so professional advice is recommended.
How pension drawdown works
With pension drawdown, you leave your money invested in a pension fund, which usually means leaving it invested in the stock market.
It is possible to access up to 25% of your pension fund free of income tax, with the remainder of any withdrawals subject to income tax at your marginal rate.
You can withdraw money at regular intervals, in a similar way to a salary, or withdraw occasional lump sums. You might also choose to withdraw a large amount to pay off your mortgage, or to buy an annuity and enjoy the regular payments it provides.
Alternatively, you might decide not to touch the money at all, preferring to live off other savings such as Individual Savings Accounts (ISAs). This leaves as much money in your pension pot as possible, an attractive option when considering how to pass on your wealth as inheritance tax does not apply to the majority of pensions.
What are the advantages of income drawdown?
The main advantage of pension drawdown is flexibility. You can access your pension funds as and when you wish.
Drawdown can be an excellent way to boost income in retirement, or to allow you to vary your income to meet different requirements at different stages of your retirement.
It allows you to keep your money invested in the stock market, which means it can still benefit from investment growth, allowing you to sustain your chosen level of income for longer.
This means it may grow to provide a larger sum and in doing so, enable you to withdraw a larger income in due course, or simply make your chosen level of income last longer.
What are the disadvantages?
Just as remaining invested in the stock market provides you with the possibility of more growth, investments can fall in value as well as rise. You may see the value of your investments fall and therefore your money may not last as long as you would like it to, or you may have to take a smaller income if your investments do not perform well enough.
Many people also underestimate how long they will live. If this happens, even with a conservative approach to your spending, you could run out of money too soon. It is important to get professional advice about how the level of your income will affect the size of your pension using various different assumptions about investment growth.
You can then devise a strategy for calculating the right level of income for your circumstances, ensuring that you have enough to pay essential fixed costs such as food and bills for your lifetime, plus any luxuries or holidays.
Things to consider
According to a survey by the Financial Conduct Authority, a third of savers take no financial advice on how to invest pensions cash held in a drawdown plan, and one in three have no idea how their money has been invested .
You should be asking yourself how comfortable you are with the potential for your money to go down, whether your investment growth is on target, and whether the charges you are paying are competitive.
Not all pension schemes offer pension drawdown. You need to contact your provider to see if drawdown is a possibility. Finally, if you do choose pension drawdown, you need to review your chosen investments regularly to ensure they stay in line with your requirements both now and throughout your retirement.
If want to make sure you are on track for the retirement you aspire to, contact us here.
The value of investments can fall and you may get back less than you invested.
Past performance is not a guide to future performance.
No investment is suitable in all cases and if you have any doubts as to an investment's suitability then you should contact us.
The information contained in this article is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
Please note that this article was prepared as a general guide only and does not constitute tax or legal advice. While we believe it to be correct at the time of writing, Brewin Dolphin is not a tax adviser and tax law is subject to frequent change. Tax treatment depends on your individual circumstances; therefore you should not rely on this information without seeking professional advice from a qualified tax adviser.