How do pension drawdown contracts work?

Coins with years going into distance

Ask the expert at Smith & Pinching about pension drawdown withdrawals - Credit: Getty Images/iStockphoto

I am thinking about retiring next year and have begun to investigate what level of income I might be able to achieve from my pension fund. I have built up about £310,000 in my fund – and it was a little higher at the beginning of the year. I understand that the rules now allow you to use your pension fund a bit at a time in drawdown, but I don’t really understand how that works. Can you explain, please?

Financial adviser sitting at a desk

Richard Barker is a Chartered Financial Planner with Smith & Pinching. - Credit: Smith & Pinching

Richard Barker of Smith & Pinching responds:

There was a time when retiring meant that you spent your whole pension fund all at once to buy an annuity – an income for life – which meant making irrevocable decisions at the outset. You are right that, under pension freedom rules that were introduced in 2015, you now have a different option in the form of income drawdown.

With a drawdown contract, your pension savings are invested for growth with a pension provider and you take withdrawals as and when you wish direct from your savings. This doesn’t have to be the provider you used when you built up your pension fund. This approach has a number of advantages. Firstly, your pension has the potential to continue to grow throughout your retirement. Secondly, you can vary the amount of income you take as your needs in retirement change: you might, for example, want to spend more in the early years of your retirement while you are active and less when you are a little older. Thirdly, using the whole fund to buy an annuity when markets are low could have a negative impact on the income you might achieve, whereas taking limited withdrawals in times of poor market performance will limit the impact of any losses.

However, there are two main drawbacks to drawdown. Firstly, there is the possibility that you might deplete your pension savings by taking too much out too soon and, secondly, you do need to monitor and manage the performance of the underlying investments on a regular basis to ensure that they continue to deliver the growth you need to maintain your income. Your retirement pot remains invested while in drawdown, therefore ensuring a suitable level of investment risk on an ongoing basis is vitally important. Cashflow modelling is a very useful tool that can be used when planning your income needs in retirement and this will help you understand if your retirement objectives are likely to be achievable.

The annuity versus drawdown debate is not clear cut. There are other options – direct withdrawals without entering into a drawdown contract, for example – and it is possible to have a mix of more than one type of arrangement.

The important thing is to understand what your options are and how your fund can best be used to give you the retirement lifestyle you want. Receiving Independent financial advice, ideally from a Chartered Financial Planner who has experience in cashflow modelling, is really important at this critical time, as you begin the put meat onto the bones of your retirement plans.

Any opinions expressed in this article do not constitute advice. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.

Fore more information visit www.smith-pinching.co.uk

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