Almost 400,000 people have withdrawn £6 billion from their pensions since April last year. But you need to handle your cash with care, do you need to take all of your pension now?
Pension flexibility is liberating. You’ve worked hard all your life and at last you have a big pot of cash, and with pension freedoms, you can use it however you want. With this freedom comes risk.
Just because you can take a cash lump sum doesn’t necessarily mean you should.
What has changed?
Key pension changes from 2015’s budget include removing the need to buy an annuity to provide income until you die, giving access to schemes previously restricted to wealthier savers and axing the 55% ‘death tax’ on pension pots left invested.
Best of all, you are no longer limited to one chance to take a single tax-free lump sum worth 25% of your pension pot with the rest taxed as income. You can now dip in and make as many withdrawals as you want, each time getting 25% tax-free and the rest taxed like income.
The changes apply to people with ‘defined contribution’ or ‘money purchase’ pension schemes, which take contributions from both employer and employee and invest them to provide a pot of money at retirement. Final salary or ‘defined benefit’ pensions that provide a guaranteed income after retirement are not included.
Cashing in your pension pot
Of course, many of our clients arrive at retirement and plan to use some of their pot to pay off outstanding bills, often their mortgage. As part of a sensible plan to manage your wealth, there should be no problem. But there should be caution.
The number of people cashing in their pensions was 159,000 in the three months to July 2016, almost double previous quarters.
The over-55s are becoming used to the concept of dipping in and out of their savings as and when they want. Every pound of pension you take today will not be available as income later. And there could still be plenty of later to think about.
Projections assume the average 55 year old will live into their 90s. You could find you are in financial trouble later in life if you withdraw too much money in the early years, this is called longevity risk.
There could be some serious tax implications too.
The taxman wants your cash
One of the biggest worries about taking out cash from your pension is the taxman, who will want to help himself to a share of it.
If you draw a cash sum from your pension the first 25% each year is tax-free, but you may pay tax on the rest. Pension withdrawals are added to your other earnings and taxed at according to your marginal income tax rate.
If you withdraw more, the taxman could take a large chunk, so it may be wiser to spread withdrawals.
Income drawdown is the increasingly popular alternative. Here you leave your money invested while drawing a regular income. This seems to be a sensible choice, but there is still a risk that markets could fall in the future and reduce the amount of income available for you to draw. Conversely, you could benefit substantially if markets rise.
What about an annuity?
You could of course also withdraw some of your pension as cash and use the rest to buy an annuity.
Buying an annuity guarantees income for as long as you live. This gives security but rates have fallen, so can mean less income. It may be worth buying an annuity with at least some of your money to cover bills and other essentials.
A guaranteed income for life should be at the core of your financial planning – and you really can’t afford to take any chances.
Remember that if you are thinking about making withdrawals, you need to be beware of fraudsters, who consider your pension pot to their honey pot. You can see our guidance on protecting yourself from financial fraud by clicking here.
What should you do?
- Get a statement showing what your pot is worth and what income it is likely to make. Check for extras such as guaranteed annuity rates.
- Don’t withdraw too much in the early years. You are likely to live longer than you think.
- Consider how much investment risk you are willing to take. Income drawdown is flexible but your pension is at the mercy of stock market movements and you may prefer the security of an annuity.
- If buying an annuity always shop around for the best deal as you could receive up to 30% more income if you have a medical condition, smoke heavily or are overweight.
You should also get professional advice – it is actually a government stipulation before taking a large cash sum out of your pension pot. We can help to plan your cash flow and calculate how much income you can achieve from your pension savings. Get in touch today to get your personal review.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.
Your pension income could also be affected by interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
The Financial Conduct Authority does not regulate wills, taxation and trust advice.