How does drawdown work? 

Lets keep things simple and ignore compound interest and tax, and take a look at how it works...

If you had, say, £100,000 in a building society account paying 4% interest then you would have £104,000 at the end of the year. If your income draw was £500pm then you would have taken £6,000 over the course of the year and you would be left with £98,000 - you have drawn £4,000 in interest and £2,000 of your capital.

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Building Societies are safe but the returns are not very good. You might think the same of annuities, which work in a similar way (i.e. drawing interest \ spending capital) only an actuary has worked out how long you will live and therefore how long he can pay you a guaranteed income while still leaving a profit for himself.

Rather than invest in the analogy of a Building Society account (i.e. annuity) you might feel a better return could be achieved from equities, in which case lets leave the money invested in equities within your pension plan. Lets assume you can achieve a return of 8% over the year. This would satisfy your income draw of £500pm and your pension would have grown by £2,000 to be worth £102,000. Next year you would be a year older and have more money to buy an annuity with, both of which will provide you with a greater income. You might choose to do the same in the second year and so on.

Sounds good but there is a drawback with equities, they can fall in value too! What if there was no investment return? In this situation you would have spent £6,000 of your capital and you would be left with £94,000. Worse still, you could experience negative returns. In the second year it would be difficult to claw back the loss and continue to provide an income. So, this strategy carries risks but you can manage the risk in the normal way by spreading your fund across different asset classes. 

  go to Drawdown Calculator