How Does Pension Drawdown Work?

One of the options available to you when accessing your hard-earned pension pot is pension drawdown. But what exactly is pension drawdown? How does it work, and what do you need to consider before diving in?

Imagine having the freedom to decide how and when you withdraw money from your pension pot, rather than just receiving a fixed income every month as you would with Defined Benefit or a Final Salary pension. That's what pension drawdown offers— flexibility and control over retirement funds. It sounds great, but like all important financial decisions, it comes with its own set of considerations and potential pitfalls.

What is pension drawdown?

From the age of 55 (or 57 starting April 6, 2028), you can dip into your pension pot whenever you need some extra cash while leaving the rest of your money invested. It's also known as income drawdown or flexi-access drawdown.

You can normally take up to 25% of your total pension savings tax-free, up to a maximum of £268,275. You can take this generous allowance as one big lump sum, or if you prefer, spread it out over a few smaller tax-free withdrawals. You even have the option to receive an income that blends both tax-free and taxable elements.

What is a drawdown pot?

When you decide to go into drawdown, your provider will split your pension pot into two parts: a drawdown pot and a savings pot. These two pots will often be referred to as a Crystallised and Uncrystallised pension pots. The Crystallised pot being the one liable to income tax and the Uncrystallised pot being the one with your tax-free cash entitlement. Accessing your tax free cash is referred to as ‘Crystallising’ your pension.

This helps keep track of your tax-free cash entitlement as you take money out, while still giving you the option to add more money into your pension if you fancy doing so.

Up to 25% of the money in a savings pot, or uncrystallised pot, can be paid tax-free. Anything in a drawdown pot will be considered taxable income when you decide to access it.

To make sure you stay within your tax-free allowance, your provider has a clever system. For every £1 you pay yourself tax-free from a savings pot, they’ll automatically move £3 from the savings pot into the drawdown pot.

Here are a few ways you might take your tax-free cash entitlement:

Taking a one-off tax-free lump-sum:

Let’s imagine you have a £100,000 pension pot: Your provider hands you a £25,000 tax-free lump sum. That’s your full 25% tax-free allowance coming straight from your savings pot.

The remaining £75,000 gets moved into your drawdown pot. This amount will be taxed as income at your marginal rate when you decide to access it. Keep in mind that your personal circumstances, including where you live in the UK, will affect the tax you pay.

With this option, you’ve fully used up your tax-free allowance—unless you decide to top up your savings pot with more money down the line.

Your tax free cash entitlement within a pension is referred to as a PCLS or Pension Commencement Lump Sum.

Take a series of tax-free lump sums:

Now, instead of grabbing all your tax-free cash in one big lump sum, you might want to spread it out over a series of smaller chunks.

Let’s say you want to take a £10,000 tax-free payment: your provider would move £30,000 into your drawdown pot. Remember, for every £1 you take out tax-free, £3 gets moved to your drawdown pot. The amount within your drawdown pot is ready to be accessed as taxable income whenever you need it. This leaves you with £60,000 still untouched in your savings pot. You can still take 25% of that as a tax-free payment later on.

Making use of tax allowances

Lets look at a smart strategy to make the most of your allowances and reduce taxes in drawdown:

One popular approach among retirees is to draw an income from their crystallised pot to fully utilise their tax-free personal allowance each tax year.

Here’s how it works: UK taxpayers have a tax-free personal allowance of £12,570 for the current 2024/25 tax year. Let’s say you’re a pension holder with no other income for the year: You can move £12,570 into your drawdown pot for the year, which can be withdrawn completely tax-free.

This move also comes with a tax-free cash payment of £4,190. So, in total, you’re looking at a tax-free income of £16,760 for the year.

This strategy allows you to make the most of your pension pot while keeping your tax bill at zero. It’s a great way to enjoy your retirement income without giving a chunk of it to the taxman.

Withdrawing regular taxable and tax-free lump sums from your pension like this is referred to as UFPLS or ‘Uncrystallised Funds Pension Lump Sum’.

Drawdown 

When it comes to accessing your pension savings, drawdown gives you flexibility—you’re in control of how much money you take and when you take it.

Any money left in your pot can stays invested. The longer your money is invested, the more opportunity it has to grow, thanks to the magic of compounding.

Just remember, a pension is an investment. Its value can go down as well as up, and it could end up being worth less than what you put in. But with smart planning and a little patience, you’ve got a great chance to make the most of your retirement savings.

Get in touch

Do you have a question about pension drawdown? We’re here to make it simple. Leave us a message via the submission form button below, and let’s chat. We’re always happy to help.

No financial decisions should be taken based on the content of this website or associated videos. The guidance contained within this website is subject to the UK regulatory regime and is therefore primarily aimed at viewers in the UK. Always take full individual advice first. Regulations and legislation governing taxation, investments and pensions may change in the future.

The content on this page is accurate as of the 2024-25 tax year.