Pension Drawdown: Making Your Money Last
Flexi-access drawdown gives you complete control over your pension income. But with that freedom comes responsibility—you need a strategy to ensure your money lasts as long as you do.
How Drawdown Works
With pension drawdown, your pension pot stays invested. You can take income flexibly:
- 25% tax-free: You can take the tax-free portion up front, gradually, or not at all
- Flexible income: Take as much or as little as you want, when you want
- Ongoing investment: Your remaining pot continues to grow (or shrink) with markets
The Sustainable Withdrawal Rate
The key question: how much can you safely withdraw each year without running out? The traditional "4% rule" (based on US research) suggests withdrawing 4% of your initial pot, adjusted for inflation.
For the UK, many advisers suggest 3.5-4% as a starting point, considering:
- Lower expected returns from UK bonds
- Longer life expectancy
- Potential for poor returns early in retirement (sequence risk)
Example: A £500,000 pension pot at 4% withdrawal rate = £20,000 per year initial income (before tax), adjusted for inflation each year.
Withdrawal Strategies
1. Natural Yield
Only take the dividends and interest your investments produce. Capital remains intact. Very conservative—may leave money behind, but removes the risk of depleting your pot.
2. Percentage of Pot
Take a fixed percentage (say 4%) of your current pot value each year. Income fluctuates with markets, but you can't run out. Bad years mean lower income.
3. Fixed (Inflation-Adjusted) Amount
Take a set amount that increases with inflation. Provides stable, predictable income. Risk: if markets perform poorly, you could deplete your pot.
4. Bucket Strategy
Divide your pot into short-term (cash), medium-term (bonds), and long-term (equities) buckets. Draw from cash, refilling from bonds and equities over time. Provides psychological comfort during market drops.
Sequence risk: If markets drop sharply early in retirement while you're withdrawing, recovery is much harder. Consider holding 2-3 years' expenses in cash or bonds to avoid selling equities during downturns.
Combining with Other Income
Your drawdown strategy should factor in other income sources:
- State Pension: Currently ~£11,500/year at full rate, starting at age 66 (rising to 67 and 68)
- ISA withdrawals: Tax-free income that doesn't affect your tax bands
- Part-time work: Earnings in early retirement reduce the pressure on your pension
- Final salary pension: Guaranteed income reduces the risk of running out
Tax Efficiency in Drawdown
Every pound of drawdown income (beyond the 25% tax-free) is taxed as income. Consider:
- Stay within basic rate: Plan withdrawals to stay under £50,270 (including State Pension)
- Use your personal allowance: The first £12,570 is tax-free
- Supplement with ISA: When you need more, draw from ISA to avoid higher rate tax
- Timing large withdrawals: Spread over multiple tax years if possible
Reviewing Your Strategy
A drawdown strategy isn't set-and-forget. Review annually and consider adjusting if:
- Markets have performed significantly better or worse than expected
- Your spending needs have changed
- Your health or life expectancy outlook has changed
- Tax rates or allowances have changed
How Talk Through Wealth Helps
Model your drawdown strategy and stress-test it:
- Project how long your pot will last at different withdrawal rates
- See the impact of poor early returns (sequence risk)
- Combine pension with State Pension, ISA, and other income
- Optimise the mix of tax-free lump sum and taxable income
- Model different strategies: natural yield, percentage, fixed amount
Model Your Drawdown Strategy
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