- Savers are being urged to ‘stop and think’ before accessing their retirement pot during ‘peak withdrawals season’ in April, June and July
- Flexible pension withdrawals traditionally spike at the start of the tax year, as savers take advantage of a fresh set of tax allowances
- The only exception to this was in 2020, when uncertainty caused by the pandemic saw savers pause or reduce withdrawals
- With Brits facing higher living costs as a result of surging inflation in the last 12 months, withdrawals will could hit new highs in April, May and June 2023
- Sustainability of withdrawals, investment growth and pension tax allowances among key considerations for those considering dipping into their retirement fund
Tom Selby, head of retirement policy at AJ Bell, comments:
“The start of the tax year is traditionally peak pension withdrawal season, with hundreds of thousands of savers dipping into their retirement pot – many for the very first time.
“This time last year saw a particularly sharp spike in withdrawals, with a record £3.6 billion of taxable payments withdrawn from pensions flexibly by over 500,000 people during the quarter, at an average of £7,000 per withdrawal.
“This represented a staggering 23% increase compared to the same quarter in 2021, with surging inflation undoubtedly a significant factor as many savers were forced to turn to their pension pots to make ends meet.
“With inflation remaining persistently high and millions of households facing eye-watering increases in housing costs, we are likely to see another surge in pensions access over the next three months.
“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.”
Source: HMRC (Private pension statistics commentary: September 2022 - GOV.UK (www.gov.uk))
Five reasons to ‘stop and think’ before accessing your pension pot early or hiking withdrawals during the cost-of-living crisis
- Early access increases the risk of 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 of the game remains providing 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.
“In 2023/24, the full flat-rate state pension benefits from a bumper 10.1% increase, raising its value from £185.15 per week (£9,627.80 per year) to £203.85 per week (£10,600.20 per year). While this represents a valuable foundation income, it falls a long way below the spending needs of most people.
“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.”
- Early access could also see you miss out on investment growth
“The sustainability problems created by taking an income early from your pension will be compounded if you miss out on investment growth at the same time.
“While savers have total freedom over how to invest their retirement fund, it usually makes sense to take a bit less risk when you start taking an income from your pot.
“At the very least you will need to sell some of your investments to make a withdrawal, meaning you might have somewhere between 12-24 months of income held in cash. This lower risk portfolio will inevitably have lower return expectations over the long-term.
“What’s more, anyone taking money out of their pot early will have any investment growth applied to a smaller pot of money.
“For example, take someone with a £100,000 pension pot. If they withdraw £10,000 on their 55th birthday and enjoy 4% investment growth after charges, by age 65 their fund could be worth £133,000.
“If they didn’t take the £10,000 out and enjoyed the same level of investment growth, by age 65 their fund could be worth £148,000 – £15,000 more.”
- You could trigger a big cut in your annual allowance
“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.
“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 in his March Budget 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 3 previous tax years. Taken to its extreme, this could mean the maximum amount you can contribute to a pension in 2023/24 is reduced from £180,000 (1 x £60,000 annual allowance in 2023/24 plus 3 x £40,000 annual allowances from 2020/21, 2021/22 and 2022/23) to just £10,000.
“If you are struggling to make ends meet and your pension is the only asset available to support you, consider just taking your tax-free cash (or a portion of your tax-free cash) as this won’t trigger the MPAA.
“Alternatively, it is also possible to access up to three personal pensions worth £10,000 or less – and unlimited occupational pensions – without triggering the MPAA, provided you exhaust the entire pot in one go.”
- Hiking withdrawals risks hurting sustainability
“It is not just those accessing their pension early who could be at risk during this cost-of-living crisis – a period of high inflation presents a major challenge to anyone drawing a retirement income.
“Most people will want their pension withdrawals to increase in line with inflation in order to maintain their living standards. However, if inflation continues to run well above the 2% Bank of England target, this will have a big impact on the sustainability of a withdrawal plan.
“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.
“Inflation is unfortunately entirely out of our control. However, anyone planning to increase their withdrawals to maintain their spending power during the current period of high inflation should think about the impact on the sustainability of their plan.
“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.”
- Don’t forget about inheritance tax
“Pensions are no longer just about providing an income in retirement. Since 2016, savers have been able to pass on leftover pensions 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.
“The removal of the lifetime allowance tax charge from 6 April 2023 makes the tax treatment of pensions on death even more attractive.
“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 in order 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 IHT 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.”
