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).
  • After that, you need to 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 BandTax RateIncome Range
Personal Allowance0%Up to £12,570
Basic Rate20%£12,571 to £50,270
Higher Rate40%£50,271 to £125,140
Additional Rate45%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

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  
FlexibilityYou 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.
ControlYou 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 sumYou 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 choiceYou 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 growthYour 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 riskYour 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 guaranteesYour retirement income is not guaranteed and depends on investment performance.With an annuity, your retirement income is guaranteed for life.
ComplexitySIPP 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 TypeWhat is it?ProsCons
Stocks and SharesOwnership in individual companiesPotential for high returns, growthRisk of losing money, market ups and downs
FundsCollection of stocks, bonds, or other investmentsSpreads risk, professional managementFees, and performance depends on the fund manager
Investment TrustsClosed-ended funds that invest in various assetsSpreads risk, potential for income/growthFees, and prices can be above or below asset value
ETFs and Index FundsFunds that track a market indexLow fees, spreads risk, easy to buy/sellTied to overall market performance
Ready-made SIPP PortfoliosPre-selected mix of investments for your SIPPEasy to start, diversified, low effortLess control, performance depends on selection
Managed SIPP PortfoliosInvestments chosen by a professional managerExpert management, tailored to your goalsHigher fees, depends on manager’s performance
PropertyReal estate investments, e.g., commercial propertySpreads risk, potential income, inflation hedgeLess liquidity, tied to property market

What are the disadvantages of a drawdown pension?

Here’s a quick summary in a table: 

DisadvantagesExplanation
Investment riskYour income can be affected by market fluctuations.
Running out of moneyYou might outlive your pension if you withdraw too much.
ComplexityManaging a drawdown pension can be more difficult.
CostsHigher ongoing fees compared to an annuity.
Tax implicationsWithdrawals, except for the first 25%, are subject to tax.
Market timingSelling during market downturns can harm your pension.
ResponsibilityYou (or your adviser) must manage investments and income.

FAQs

How much can I drawdown from a SIPP?

There is no fixed limit on how much you can draw down from a SIPP. However, you should consider your retirement goals, the performance of your investments, and the risk of running out of money before deciding on an appropriate withdrawal amount.

Is a SIPP the same as a drawdown pension?

A SIPP (Self-Invested Personal Pension) is a type of pension that offers more investment choices and flexibility. A drawdown pension is an option within a SIPP that allows you to withdraw income while keeping your pension fund invested.

What is the 4% drawdown rule UK?

The 4% drawdown rule is a general guideline, not specific to the UK, suggesting that 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. This rule aims to minimize the risk of running out of money during retirement.

Can I drawdown 100% of my pension?

Yes, you can withdraw 100% of your pension as a lump sum. However, only the first 25% is tax-free, and the remaining 75% is subject to income tax. Withdrawing your entire pension may not be the most tax-efficient option and could leave you with less money for your retirement.

Can I take 25% of my pension tax-free every year?

No, the tax-free allowance applies only to the first 25% of your total pension pot. Once you’ve taken the initial 25% tax-free lump sum, any further withdrawals will be subject to income tax.

What is the most tax-efficient way to draw a pension?

Taking the 25% tax-free lump sum.
Withdrawing an income within your personal income tax allowance.
Spreading withdrawals over multiple tax years to avoid higher tax brackets.