How drawdown works

Drawdown leaves your pension invested and lets you take money out as you choose. Normally you take up to 25% as tax-free cash and move the rest into a drawdown arrangement, from which withdrawals are taxed as income. There is no fixed schedule. You can take a lot one year and nothing the next.

What it costs

Charges matter more in drawdown than in accumulation, because you are paying them on a pot that is shrinking rather than growing. Platform fees, fund charges and any adviser fee all come out of the same money you are trying to live on. A percentage point of annual cost over a twenty-year retirement is a large number.

The risk that decides everything

The danger in drawdown is not just poor returns, it is when they happen. Falls in the first few years, while you are also withdrawing, do lasting damage because there is less capital left to recover. The same average return with the bad years later leaves you far better off. This is why drawdown suits people with flexibility over what they withdraw and when.

How much you can safely take

Rules of thumb exist and none of them survive contact with a real retirement. The honest answer is that a sustainable rate depends on your age, your other income, how much of your spending is fixed, and whether you can cut back in a bad year. Someone with a large guaranteed income can afford to take more risk with the rest than someone whose pot is their only source of money.

Drawdown or an annuity

Drawdown keeps control and accepts risk. An annuity gives up control and removes it. Neither is right for everyone and the choice is not binary: buying an annuity to cover essential bills and leaving the rest invested is one option.

A worked example: Why the order of returns matters

Two people retire with £250,000 and take £12,500 a year. Over twenty years both experience the same set of annual returns, but in opposite order. One gets the poor years first, the other gets them last.\nThe one who suffers losses early is withdrawing from a shrinking pot, so there is less capital left to recover when markets turn. The one whose bad years arrive later has already banked growth. Identical average returns, very different outcomes. It is why flexibility over what you withdraw matters more than picking the right funds.

Figures are illustrative and rounded, used to show how the rule works. Your own numbers will differ.

A second example: What flexibility is actually worth

Two retirees each hold £200,000 and want £10,000 a year. Markets fall 20% in their second year.\nOne takes the full £10,000 regardless, selling more units at a depressed price. The other drops to £6,000 for eighteen months by deferring a holiday and a car change. When markets recover, the second has materially more capital left. Neither picked better investments. One simply had room to take less.

At a glance

Common mistakes

• Taking a fixed income regardless of how markets have performed.
• Ignoring charges, which bite harder on a shrinking pot than a growing one.
• Assuming an average return will arrive evenly year by year.
• Having no plan for a year when the pot falls sharply.

What to do next, in order

1. Work out which of your costs are essential and which are discretionary.
2. Check what guaranteed income you already have, including the State Pension.
3. Establish what you would cut in a bad year, before you need to.
4. Review the withdrawal rate annually rather than setting it once.

Key terms, in plain English

Drawdown

Leaving your pension invested and taking money from it flexibly, rather than exchanging it for a guaranteed income.

Annuity

An insurance product that converts a pension pot into a guaranteed income for life.

Defined contribution

A pension built from contributions and investment growth. What you end up with depends on what went in and how it performed. Most modern workplace and personal pensions are this type.

Sequence of returns risk

The risk that poor investment returns early in retirement do lasting damage because you are withdrawing at the same time.

Money Purchase Annual Allowance

A much lower annual contribution limit that applies once you take taxable income flexibly from a defined-contribution pension.

Who this affects most

Drawdown suits people with other guaranteed income, flexibility over what they spend, and the temperament to watch a balance fall without panic. It suits badly anyone whose entire retirement income depends on the pot and who has no room to cut back. Most people sit between the two, which is why some people use partial annuitisation.

Common questions

Where to check the official figures

Pension figures change every tax year. These are the free, official sources. Check the current number before you act on anything here.

• Check your State Pension forecast, GOV.UK
• Check your National Insurance record, GOV.UK
• Pension Tracing Service, GOV.UK
• MoneyHelper, pensions and retirement
• The FCA Register, check any firm

Where to go next

• Combining pensions: our main guide
• The NHS Pension Scheme explained
• The LGPS explained
• The Teachers’ Pension Scheme explained

The bottom line

We do not provide pension advice and we are not pension advisers. We introduce you to a carefully selected, FCA-regulated pension adviser. The introduction costs you nothing. If you go ahead, we may be paid a fee by that firm. Pension rules and figures change, and what is right depends on your own circumstances.