SIPP Drawdown | How To Draw Down Tax-Efficiently

SIPP drawdown is a way to access your retirement savings in a flexible manner.

Drawdown refers to the process of withdrawing money from your pension account after you reach a certain age, usually 55 or older. 

Instead of buying a fixed-income product like an annuity, which pays you a set amount of money every month, you can choose to “draw down” your savings as needed.

In simpler terms, SIPP drawdown allows you to access your retirement savings in a flexible way, so you can decide when and how much money you want to withdraw to cover your living expenses during retirement. 

This can be helpful for people who want more control over their financial decisions and the ability to adjust their income based on their needs and changing circumstances.

So, how do you draw down tax efficiently?

There are many factors at play, and it ultimately depends on your personal situation and income profile, but here are the basics:

• You can take 25% of your SIPP tax-free (commonly known as your Tax-Free Cash).
• But you may want to stagger this throughout your retirement to protect your tax allowances in each year.
• You also can look at spreading your income over multiple tax years to keep your income in the lowest tax bracket possible.
• Keep in mind that if you’re receiving your state pension, you might not have much wiggle room before you start paying at least the 20% basic rate tax.
• But if this is the case, if you can keep your income under £50,270 per year and avoid paying that higher rate tax (40%), you could pay significantly less tax throughout your full pension drawdown lifecycle.

We’ll break this down further in this guide and provide some examples to give you a better understanding, and also give you some ideas on how much you should actually draw from your SIPP each year, hitting that sweet spot of making the most of your hard-earned savings, without worrying about running out.

To get peace of mind that you’re getting the absolute most out of your SIPP drawdown funds and living your retirement to the fullest – we recommend speaking to a SIPP adviser like ourselves. Book a free, initial consultation with an adviser to see how we could help.

How does a SIPP drawdown work?

SIPP drawdown works by allowing you to withdraw money from your Self-Invested Personal Pension (SIPP) in a flexible way during retirement. Here’s a basic explanation of how it works:

1. Generally, you can start accessing your SIPP funds when you’re 55 or older. This age limit may change in the future, so it’s essential to stay informed about the current rules.
2. With a SIPP drawdown, you can choose how much money you want to take out and when you want to take it. You can withdraw a portion of your savings as a lump sum, or you can set up regular withdrawals, like a monthly or yearly income.
3. When you start taking money out of your SIPP, usually, up to 25% of your pension pot can be withdrawn tax-free. The remaining 75% will be subject to income tax when you withdraw it.
4. While you’re in the drawdown phase, your remaining pension funds can continue to be invested in various assets, such as stocks, bonds, or funds. This means your pension pot has the potential to grow, but it’s essential to understand that the value can also go down due to market fluctuations.
5. Since SIPP drawdown allows you to have more control over your retirement income, you can review and adjust your withdrawal amounts and investment strategy as needed to suit your financial needs and goals.

How SIPP drawdown is taxed

Pension drawdown is taxed the same as any other form of income, except you get to take 25% of your pension tax-free. The rest you’ll pay income tax on.

Tax-free cash

When you start drawing down from your SIPP, you can typically take 25% of your pension pot as a tax-free lump sum. This means you won’t have to pay any taxes on that portion of your retirement savings.

Tax on withdrawals

The remaining 75% of your pension pot is subject to income tax when you withdraw it. 

The amount of tax you’ll pay depends on your total income for the year, which includes your SIPP withdrawals, any other pension income, and any other sources of income you might have. 

Your total income will be taxed according to the standard income tax rates and bands:

Tax Band	Tax Rate	Income Range
Personal Allowance	0%	Up to £12,570
Basic Rate	20%	£12,571 to £50,270
Higher Rate	40%	£50,271 to £125,140
Additional Rate	45%	Over £125,140

These tax bands and rates may change over time, so it’s important to stay informed about the current tax rules.

Emergency tax

When you first start drawing down from your SIPP, you might temporarily be charged an “emergency tax” on your withdrawals.

This can result in a higher tax bill initially, but you can usually claim a refund for any overpaid tax, and your future withdrawals will be taxed at the correct rate.

SIPP Drawdown Tax Examples

Example 1:

Pension pot: £200,000

Rental income: £5,000/year

• Tax-free cash (25%): £200,000 x 0.25 = £50,000 (no tax)
• Taxable income (75%): £200,000 x 0.75 = £150,000
• Annual withdrawal: £8,000 (4% of pension pot) + £5,000 (rental income) = £13,000

Income tax calculation:

• Personal Allowance: £12,570 (tax-free)
• Basic Rate: £430 (taxed at 20%)
• Total tax: £430 x 0.20 = £86

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Example 2:

Pension pot: £300,000

Part-time work income: £12,000/year

• Tax-free cash (25%): £300,000 x 0.25 = £75,000 (no tax)
• Taxable income (75%): £300,000 x 0.75 = £225,000
• Annual withdrawal: £12,000 (4% of pension pot) + £10,600 (state pension) = £22,600

Income tax calculation:

• Personal Allowance: £12,570 (tax-free)
• Basic Rate: £10,030 (taxed at 20%)
• Total tax: £25,700 x 0.20 = £2,006

These examples demonstrate how the tax-free cash and taxable income portions of a SIPP drawdown are taxed when combined with other income streams like state pensions or rental income.

Keep in mind that tax rates, bands, and personal circumstances can vary, so it’s always a good idea to consult with a financial advisor or tax professional for personalized advice.

When is SIPP drawdown a good idea?

Income drawdown can be a good option for individuals who want more flexibility and control over their retirement income than traditional annuities provide. Here are some scenarios in which income drawdown may be a suitable option:

	SIPP Drawdown	Annuities
Pros
Flexibility	You can choose how much income to take and when to take it and can adjust your income based on changing circumstances.	Once you’ve bought an annuity, your income is fixed for life and you can’t adjust it.
Control	You have control over your remaining pension savings and can choose how they’re invested.	With an annuity, you give up control over your pension savings in exchange for a guaranteed income.
Tax-free lump sum	You can usually take up to 25% of your pension savings as a tax-free lump sum.	Annuities typically don’t offer a tax-free lump sum.
Investment choice	You can choose how your remaining pension savings are invested, giving them the potential to grow or decrease based on market performance.	Annuities don’t offer investment choices or potential for growth.
Potential for growth	Your remaining pension savings stay invested and have the potential to grow, providing a source of income for a longer period.	Annuities don’t offer the potential for growth.
Cons
Investment risk	Your remaining pension savings are subject to investment risk, meaning their value can go down as well as up.	With an annuity, you give up investment risk in exchange for a guaranteed income.
No guarantees	Your retirement income is not guaranteed and depends on investment performance.	With an annuity, your retirement income is guaranteed for life.
Complexity	SIPP drawdown can be complex to manage, particularly if you’re not familiar with investing.	Annuities can be complex to understand and set up.

How much should I take from my SIPP?

Choosing your income in drawdown involves balancing your current income needs with the need to preserve your pension savings for the long term.

Start by identifying your essential living expenses, such as housing costs, food, and bills. Make sure you have enough income to cover these expenses.

Then, think about your lifestyle: consider any additional expenses you may have, such as travel, hobbies, or entertainment.

Keep an eye on your pension pot and remember that your remaining pension savings will need to last for the rest of your life.

Review your income regularly as your income needs may change over time, so it’s important to make adjustments as needed.

And remember, consider speaking with a financial advisor who can help you navigate the complexities of drawdown and ensure you’re making informed decisions about your retirement income.

Some people find the 4% rule helping for getting a rough idea of how much to take from your SIPP:

The 4% drawdown rule is a general guideline suggesting you withdraw no more than 4% of your pension fund in the first year of retirement, and then adjust that amount for inflation in subsequent years. The idea is that your pension pot will last up to 25 years which would hopefully see you through retirement.

This is just a very rough calculation to give you an idea of where you need to be, and shouldn’t be used as a final retirement figure.

What should I invest in for SIPP drawdown?

If you’re changing your investment strategy as you move into SIPP drawdown, there are a few important considerations to keep in mind:

1. Think about your investment goals and how they may have changed as you enter drawdown. Consider factors like your desired income level, risk tolerance, and long-term financial goals.
2. Review your existing investments and determine whether they align with your new investment goals. Consider whether you need to adjust your asset allocation or make other changes to your investment portfolio.
3. If your asset allocation has drifted from your desired targets, consider rebalancing your portfolio to bring it back in line with your goals.
4. Diversification is key to managing investment risk. Consider diversifying your investments across asset classes and geographies to spread risk and potentially increase returns.
5. Regularly monitor your investments and make adjustments as needed based on changes in market conditions or your personal circumstances.

Here’s a table summarising some popular SIPP investments and their pros and cons so you can weigh up your options:

Investment Type	What is it?	Pros	Cons
Stocks and Shares	Ownership in individual companies	Potential for high returns, growth	Risk of losing money, market ups and downs
Funds	Collection of stocks, bonds, or other investments	Spreads risk, professional management	Fees, and performance depends on the fund manager
Investment Trusts	Closed-ended funds that invest in various assets	Spreads risk, potential for income/growth	Fees, and prices can be above or below asset value
ETFs and Index Funds	Funds that track a market index	Low fees, spreads risk, easy to buy/sell	Tied to overall market performance
Ready-made SIPP Portfolios	Pre-selected mix of investments for your SIPP	Easy to start, diversified, low effort	Less control, performance depends on selection
Managed SIPP Portfolios	Investments chosen by a professional manager	Expert management, tailored to your goals	Higher fees, depends on manager’s performance
Property	Real estate investments, e.g., commercial property	Spreads risk, potential income, inflation hedge	Less liquidity, tied to property market

What are the disadvantages of a drawdown pension?

Here’s a quick summary in a table: 

Disadvantages	Explanation
Investment risk	Your income can be affected by market fluctuations.
Running out of money	You might outlive your pension if you withdraw too much.
Complexity	Managing a drawdown pension can be more difficult.
Costs	Higher ongoing fees compared to an annuity.
Tax implications	Withdrawals, except for the first 25%, are subject to tax.
Market timing	Selling during market downturns can harm your pension.
Responsibility	You (or your adviser) must manage investments and income.

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