What is pension drawdown and how does it work?

Drawdown isn’t the only way your pension can provide you with an income, so make sure you consider all the available options before deciding whether it’s right for you.

For example, if you want a guaranteed income in retirement, you may decide to use some or all of your pension savings to buy an annuity. This is essentially a contract with an insurance company and in return for your savings you’ll be paid a set income for life, or a fixed term. The amount of income you’ll get will depend on a range of factors including how much of your pension you’re using to buy an annuity, how old you are, whether you want the income you get to increase each year, your health, and whether you want the annuity to pay out to your spouse, partner, or someone else after you die.

Not all providers will offer you the same monthly income for your money, so it’s essential to shop around and get the best deal for your circumstances. You can find out more about how annuities work in our article Annuities explained.

Bear in mind that choosing pension drawdown or an annuity doesn’t have to be an either/ or decision, and it’s possible to go for a combination of both. For example, some people choose to use some of their pension to buy an annuity so they have peace of mind their essential outgoings will be covered, and then use drawdown to take a further income from the rest of their pension savings as and when they need to.

You also have the option of cashing in your whole pension if you want to, and if your pension scheme allows it. However, in doing so, you run the risk of landing yourself with a potentially hefty tax bill, as only the first 25% will be tax-free and you’ll have to pay income tax on the rest. You’ll also have the added difficulty of working out where to keep your pension savings after you have taken them out. If you want to keep your money in a cash account, for example, rock-bottom interest rates mean your savings will soon start to be eroded by inflation, or rising living costs. According to financial website Moneyfacts.co.uk, the average easy access account in January 2021 paid just 0.18% annual interest – that’s equivalent to just £180 a year in interest on a balance of £100,000.

Cashing in your pension could also affect your entitlement to means-tested benefits too, so you must make sure you’ve fully considered all the financial implications involved before doing this.

Author: wpadmin

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