Pensioners have been urged to “stop and think” before pulling money from their retirement pots
Savers are being urged to “stop and think” before pulling money from their retirement pots over the next few months.
The pensions experts from AJ Bell warn that the “peak” times for withdrawing pension funds are April, May and June. This is due to savers taking advantage of the new tax year. However, those looking to access some cash should be aware of potential “consequences” over the long term – some of which could be “disastrous”. Some of these consequences include triggering a cut to your annual allowance, impacting inheritance, and even running out of money to fund your retirement.
Tom Selby, director of public policy at AJ Bell, said: “The start of the tax year is traditionally peak pension withdrawal season for people with defined contribution (DC) pensions, with hundreds of thousands of savers dipping into their retirement pot – many for the very first time – in order to take advantage of a fresh set of income tax allowances. This can be a perfectly sensible thing to do provided you have a well-thought-through withdrawal plan.”
However, Tom noted that high inflation over the last two years saw many people turn to their pension pot for help and this year many may do so again as they face a major hike to their mortgage payments alongside other costs. He added: “Anyone considering accessing their pension for the first time or hiking withdrawals to cope with rising living costs should stop and think before making a rash decision.
“Taking money out of your retirement pot early or withdrawing too much, too soon could have disastrous consequences over the long term. What’s more, pensions benefit from generous tax treatment on death, meaning it often makes sense for your retirement to be the last asset you touch.” AJ Bell has highlighted four reasons why you “stop and think” before accessing your pension pot early or hiking withdrawals.
Running out of money in retirement
Pensions can be accessed from age 55, with this minimum access age due to rise to 57 in 2028. For most people, however, the aim is to give yourself an income to support your lifestyle throughout retirement. Withdrawing too much, too soon from your fund means you’ll increase the risk of running out of money early – and potentially being left relying on the state pension.
Tom explained: “Take a healthy 55-year-old with a £100,000 pension pot. If they withdraw £5,000 a year, increasing annually in line with inflation at 2%, and enjoy 4% annual investment growth after charges, their fund could run out by age 80. Given average life expectancy for a healthy 55-year-old is in the mid-80s – with a decent chance of living well into your 90s – such an approach would clearly create a serious risk of draining your pot early.
Put simply, if you raid your pension pot early, you’ll either need to keep your withdrawals very low, potentially harming your quality of life later in retirement; find other sources of income; or face up to the prospect of your pot running out sooner than planned and being left relying solely on the state pension.
High inflation could impact your standard of living
Tom says a period of high inflation presents a “major challenge” to anyone drawing a retirement income. The majority of savers want their pension withdrawals to increase in line with inflation to maintain their living standards. However, if inflation continues to run high then it will definitely impact the sustainability of your withdrawal plan.
Tom explained: “Consider a healthy 66-year-old with a £100,000 fund who wants to withdraw £5,000 a year from their pension, rising in line with inflation. If inflation is 2% a year throughout their retirement their fund could last until age 91. If inflation is 4% a year, however, then the fund could run out by age 85 – a full six years earlier.”
Tom noted that inflation was out of our control, but those planning to increase their withdrawals to maintain their spending power should think about the impact on the sustainability of their plan.
He added: “It’s also worth taking a step back and thinking about your own personal inflation rate. The figures produced by the ONS are an average based on a weighted basket of goods, but your own inflation may be higher or lower depending on what you spend your money on. Sit down, tot up your costs and income sources, and try to design a sustainable retirement income strategy that meets your needs.”
Trigger a cut to annual allowance
The pension experts say that anyone considering withdrawing taxable income from their retirement pot for the first time needs to be aware of the severe impact it will have on their ability to save tax efficiently in a pension in the future.
Tom explained: “Taking even £1 of taxable income from your pension flexibly will trigger the money purchase annual allowance (MPAA), potentially significantly reducing the amount you can save in a pension tax efficiently. Chancellor Jeremy Hunt at least reduced this cliff edge by increasing the MPAA from £4,000 to £10,000, but that is still a lot less than the £60,000 annual allowance. Furthermore, if you trigger the MPAA you will lose the ability to ‘carry forward’ unused pensions allowances from up to three previous tax years.”
If you are struggling to make ends meet and your pension is the only asset available to support you, Tom says you should consider just taking your tax-free cash – or a portion of your tax-free cash – as this won’t trigger the MPAA.
Don’t forget about inheritance tax
Tom says pensions are no longer just about providing an income in retirement but are often a way of helping out loved ones when you die. Rules introduced alongside the pension freedoms mean savers can pass on leftover pensions completely tax free if they die before age 75. Where the pension holder dies after age 75, the remaining funds will be taxed at their recipient’s marginal rate when they make a withdrawal.
Tom said: “For those who want to leave assets to loved ones, it therefore often makes sense to leave as much of your pension untouched as possible to minimise your tax bill. This means when you come to flexibly access your pension for the first time, you should think not just of your retirement income strategy but also your inheritance tax plans. If you have money held in an ISA, for example, this will count towards your estate on death.
“For those who want to pass their pension on to loved ones, it’s also important to ensure your nominated beneficiaries are up to date so the right people inherit your pot.”
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