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Rethinking Retirement: The Case for Drip-Feed Drawdown
Accessing a pension
Generally, retirees can access their pension upon reaching the normal minimum pension age of 55 (57 from 6 April 2028). At that point, 25% of the capital value can usually be taken as tax-free cash, whilst the remainder must be used to provide a taxable pension benefit.
The tax-free cash entitlement is defined as a ‘pension commencement lump sum’ (PCLS). This is because it can only be paid at a time when the member uses the remaining 75% to start taking a pension benefit. The types of pension benefit that must be provided are:
- A scheme pension,
- A lifetime annuity, or
- Flexi-access drawdown.
Evolution in retirement options
In the past, most people would take either a scheme pension or lifetime annuity, thereby providing a guaranteed income for life that could supplement the State Pension.
Drawdown, introduced in 1995, was originally seen as an option only suitable for the minority, requiring a large pension pot and a higher capacity to take risk.
However, since 2006 (A-day), successive governments have relaxed the rules around drawdown, culminating in the pension freedoms beginning on 6 April 2015.
The pension freedoms removed most restrictions on how drawdown and annuities must be paid. In addition, a new way of accessing a pension was introduced - an ‘uncrystallised funds pension lump sum’ (UFPLS). An UFPLS allows an uncrystallised money purchase pension to be taken in one go or as a series of lump sums, with 25% of the payment being tax free.
The pension freedoms resulted in massive changes as to how consumers decide to access their pensions and the products they pick to do this.
The growth of drawdown
In 2013 (the year before the pension freedoms were announced), annuities outsold drawdown contracts by a factor of 16 to 1*. However, the pension freedoms have significantly changed consumer behaviour.
Today, the below table shows that only around 1 in 10 people are choosing to buy annuities. Most people are deciding to encash smaller pots (under £30,000), with larger pots flexibly accessed, predominantly through drawdown:
| Pots accessed for the first time** | April 2023 - March 2024 | ||
| Number | AUA Value (£000) | % of policies accessed in this way | |
| Total pots accessed for the first time | 885,455 | 52,152,463 | |
| Annuities purchased | 82,061 | 6,055,997 | 9% |
| New drawdown policies entered into and not fully withdrawn | 278,977 | 35,871,430 | 32% |
| Pots where first partial UFPLS payments taken and not fully withdrawn | 54,694 | 4,334,040 | 6% |
| Full cash withdrawals from pots being accessed for first time | 469,723 | 5,890,995 | 53% |
* Source ABI data - 353,000 annuity sales with a total value of £11.9bn, compared to 22,000 income drawdown sales with total a value of £1.2bn in 2013.
** Source FCA Retirement income market data 2023/24.
Taking tax free cash as income
As a result of how pensions are now accessed, there is less of a need for someone to take all their tax-free cash entitlement in one go. Many more people are using drawdown, meaning they access their pension pot as they choose. This means that they can now consider using tax-free cash for income – commonly known as ‘drip-feed drawdown’.
‘Drip-feed drawdown’ can increase tax efficiency and leave more money to grow within a tax-sheltered pension fund.
Example – Lee and Sian
Lee 62 and Sian 60 are looking to retire. They are mortgage free and have no immediate need for a lump sum to pay off debts, but do require a joint income of £33,000 pa (after tax) to live off.
They each have a pension pot valued at circa £400,000. As they will no longer be active members of a registered pension scheme, the money purchase annual allowance (MPAA) is not a consideration.
Their adviser recommends that they use drip-feed drawdown to each produce a monthly income of £1,397 per month.
25% (£349) of each payment will be tax-free cash, whilst the remaining 75% (£1,397) will be taxable drawdown income, as outlined in the table* below:
| Month |
Lee | Sian | Total joint income | ||||
| Tax-free | Income | Total | Tax-free | Income | Total | ||
| April | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| May | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| June | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| July | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| August | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| September | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| October | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| November | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| December | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| January | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| February | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| March | £349 | £1,048 | £1,397 | £349 | £1,048 | £1,397 | £2,793 |
| Total | £4,190 | £12,570 | £16,760 | £4,190 | £12,570 | £16,760 | £33,520 |
* Figures rounded to nearest £ pound.
The advantages of this approach are:
- It will generate a total joint income of £33,520 per year, so meets their income requirement in full.
- No income tax is payable, since all the taxable drawdown income falls within their tax-free personal allowances of £12,570 (for 2025/26). This means less pension savings are needed to provide the required income.
- The remaining pension funds can continue to grow within the tax advantaged pension wrapper, including their remaining tax-free cash entitlements.
- The minimum amount necessary is drawn from the pension. This helps minimise the risk of their funds running out in retirement.
- Although presently frozen, current Government policy is that the tax-free personal allowance will increase each year in line with the Consumer Price Index (CPI) from April 2028. If this happens, Lee and Sian will be able to increase their income each year in line with inflation without incurring an income tax liability or needing to use a higher proportion of tax-free cash.
Comment
On retirement, many people’s first instinct is to request their full tax-free cash entitlement. However, unless a large lump sum is needed for a specific purpose, this is not always the wisest course of action.
If flexibly accessing a pension, drip-feed drawdown can be a great way to maximise income tax allowances and draw pension income as tax efficiently as possible.
Note that drip-feed drawdown won’t be suitable or may not be possible where a protected retirement age or protected tax-free cash is present. In addition, sufficient Lump Sum Allowance (LSA) and Lump Sum and Death Benefit Allowance (LSDBA will be needed.
Important information
Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.
The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.
The use of this document is at your own risk, and the content should not be used for the provision of professional advice.
LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.