Drawdown pension basics: everything you need to know

George Sweeney 30th May 2022 No Comments

Reading Time: 5 minutes

With inflation tearing a hole in your pocket, you might be wondering how the cost-of-living crisis is going to impact your retirement. And, what options do you have? Is it better to go for a drawdown pension or use an annuity?

To help you navigate these tricky waters , I’m going to explain some top tips for managing your pension before and after you retire. You’ll learn what drawdown payments involve, the pros and cons, and some alternative retirement options.

Keep reading for all the finer details or click on a link below to head to a specific section…

• Living off your pension
• What is a drawdown pension?
• The different types of drawdown pensions
• How it works
• Advantages
• Drawbacks
• Alternatives

 

Living off your pension savings during high inflation

You might be reaching an age where you’re planning to live off your pension. And in today’s climate, it’s tough to figure out the best course of action.

Unless you’ve been living under a rock, you’ll have noticed rising prices and high inflation right on your doorstep.

What started out as a ‘transitory’ post-coronavirus squeeze has turned into a bursting dam which has become a regular part of your day-to-day life.

Tthe backlash from Covid-19 and the ensuing lockdowns are the main part of the problem leading to inflation, along with struggling global supply chains, and historic energy price increases at home, super high fuel costs, and to top it all off – a war in Ukraine.

However, the main cause of the inflation we are dealing with now (and will be for some time to come) is the insane amounts of money that was printed during the enforced lockdowns. As the economist Milton Friedman famously stated: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”

Alongside inflation, rising interest rates, and general anxiety, are causing downward pressure in stock markets around the world.

So, you may be wondering what you can do about your pension, if anything.

To help you get a clearer picture, I’m going to explain drawdown pensions in detail and what this could mean for your retirement.

 

What is a drawdown pension?

This is an increasingly popular way to access a defined contribution pension. It can be a more flexible way for you to use your retirement savings. But, with this flexibility comes added risks to think about.

In the past, it was very common for people to use their pension pot to purchase an annuity. This annuity would guarantee an income for life.

Annuities were a solid option for those who wanted to know exactly what their finances would look like during retirement.

But, because the average lifespan has been increasing, this has made annuity offers less and less enticing. You need an absolutely massive pension pot to get anywhere near a decent annuity deal.

A drawdown pension allows you to take out as little or as much as you’d like. But, this pot has to last you throughout retirement.

 

What are the different types of drawdown pensions?

The two main types are:

1. Flexi-access drawdown
2. Capped drawdown

However, the capped drawdown option is only available if you set it up before April 2015. So flexi-access is the norm and what most people are referring too when using the word ‘drawdown’.

 

How a drawdown pension works

Your pension pot is held in a fund. The fund will contain a specific set of investments, and you withdraw your money from here.

Depending on what your fund is invested in can impact whether your overall pot grows, remains stagnant, or shrinks.

Organising things in the right way for your retirement is best done by speaking with a financial adviser.

They can take a look at your whole finances and then give you guidance on the best arrangement of investments to use for your circumstances and goals.

 

Advantages of a drawdown pension

The flexibility of control means that you can adjust your income and how much money you use.

Some key advantages include:

• Access to more funds if you’ve got a big event or holiday planned.
• With rising prices, you may need more cash to maintain your current lifestyle.
• In the years when you don’t need as much income, you can leave your pension pot to grow.
• Retain ownership over your pot so your family can inherit an unspent pension pot free from tax if you die before 75, or income tax applies if you die at an older age.

 

Drawbacks to think about

Although accessing your retirement savings with a drawdown pension comes with lots of flexibility and control, there are some disadvantages to keep in mind:

• If you don’t manage your pension properly, you could run out of money.
• The pot can lose value depending on the performance of the investments in the fund.
• Taking money out during market downturns can harm your retirement in the long-term.
• Often requires ongoing management or advice from a professional.

 

Alternative options to drawdown pensions

There are some other ways you can access funds in retirement without drawing down from your pension pot.

Here are a few ideas worth considering:

1. Taking income from dividends and other assets

To minimise the impact of negative returns, you can take income from your underlying investments such as dividends and bonds.

This can help avoid selling fund units, giving your pension pot a better chance at recovery if the market improves at a later date.

Another option is to make use of any other assets you have, like a cash ISA.

With high inflation, your cash will be losing value. So, rather than sell pension investments at a loss, it could be a good time to smooth things out with some of your cash reserves.

2. Delay retirement

Deciding to postpone your retirement can give you some breathing room to ride out the current financial bumps.

There are no guarantees things will be better down the road. Yet, the situation we’re in right now couldn’t get much worse – I hope I didn’t jinx things by saying that.

Riding out the storm and trying to minimise the impact on your pension finances could be worth thinking about.

3. Use an annuity

Annuity rates aren’t what they used to be. But, if it gives you more peace of mind to have a guaranteed income throughout your retirement, it’s worth considering this option.

You’ll have less flexibility and control compared to a drawdown pension. But the benefit is, you’ll know where you stand with your finances today and tomorrow.

4. make some money on the side

More and more retirees are finding it handy to make some extra money to supplement their incomes. Not only are ‘side-hustles’ a good way to make extra cash to keep one going, they are also often really helpful in getting one out of the house, meeting new people and gaining new experiences.

Have a look at our article on how over-60s are making money right now (pretty amazing stuff!) for inspiration.

This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.