Approaching pension drawdown? Top questions you might need answered

When you reach the point you begin to think about dipping into your pension pot, it can often feel like an endless string of financial decisions that you must ‘get right’.

In July, the Department for Work and Pensions released its findings following in-depth interviews with people aged 53 to 67 living a variety of lifestyles across the UK. They asked them how they plan to handle their pension, what they consider when making decisions and the areas that present the most challenge to them.

There were a few key topics that kept cropping up throughout the survey when it came to accessing pensions. Below, we’re going to address the top questions and challenges raised.

Is there really a downside to taking my tax-free cash?

Getting their hands on a tax-free lump sum was a common instinct throughout the research, and for some people, it makes sense. If there’s an immediate plan to use your tax-free cash, such as paying off your mortgage, taking a long-awaited trip, or if it’s money you intend to gift to others, it can make sense to take the cash up front.

It’s important to know that if you opt to take the tax-free cash as a Pension Commencement Lump Sum, you lock in that amount as your tax-free cash, even if the value of 25% of your pension is less than the £268,275 maximum. This could leave you with less in tax-free cash if your pension continues to grow after taking your lump sum. If you have multiple pensions, they are all counted towards the same lump sum limit of £268,275.

If you intend to use it to pay into your ISA for the year, or across two tax years, it will still not be subject to any capital gains tax and will also not face income tax. But, if you withdraw more than you need to, removing it from the pension wrapper could end up costing you in the long run.

For example, if someone aged 55 had a £500,000 pension and decided to take their tax-free lump sum of £125,000, it would take seven tax years to get all that money transferred into an ISA.

Depending on your circumstances, you can opt for taking just a portion of your tax-free cash in stages, instead of the whole lump sum, as explained on Options at retirement.

How old will I be before I can access the state pension?

The state pension age began to increase from 66 in April and will reach 67 in April 2028, with plans to increase to 68 in the future. It’s no wonder this can be confusing for people, and the government has not confirmed the timeline for when the next increase to age 68 will happen. Using the government’s state pension age checker can give you an estimate, but if you’re some way off the current state pension age now, it is genuinely difficult to say what the age will be once you get there.

This obviously makes retirement planning based on the state pension unclear and means that if you’d like to be in charge of your retirement date, you’ll need to have personal savings to do so. As a starting point, the most recent Pensions UK data estimates that for a moderate retirement, you’d need a pot of £335,000 to £505,000 and for a comfortable retirement, £560,000 to £845,000 as a single person at state pension age.

I’m worried my pension won’t last as long as I’ll need it to

There’s no way to know exactly how long your retirement will be. But playing it on the safe side can be a much better bet. The worst-case scenario of being left with too much is a bit extra passed down to family and friends, whereas if you spend your savings while still alive, your later-life care could be left to the state.

One approach that’s becoming more popular to ensure your pension lasts is a phased retirement. Instead of going from full-time employment to full-time on the golf course, many are doing part-time work to bridge the gap or taking up a different sort of career entirely. Many people find this to be both fiscally and emotionally rewarding. Transitioning out of work can mean many people are left feeling a bit lost, and without their usual social interactions. This half-way step can help. Read is your pension pot on track with your peers?

The other element that can help your pension last longer is how that pension is invested. When people near retirement, there’s often an instinct to move all their assets to less risky investment strategies. While this may reduce market risk, it can increase the risk that your money doesn’t last throughout retirement.

For example, let’s say you moved a £500,000 pension pot into drawdown ten years ago and planned to withdraw £3,333 each month to live on, or £40,000 each year. If you had moved your entire investment to a cash-like fund, such as the BlackRock Sterling Liquidity Premier fund, after ten years you’d be left with just £143,514 before platform fees. But if you had invested your funds in the Fidelity Index World fund, you’d have accumulated £968,614 before fees.

While both scenarios have the same withdrawals, the growth of the money through Fidelity Index World is outpacing those withdrawals, while the growth in the cash-like fund isn’t able to keep up. These are two extremes for investing, but if you want to strike a balance in the middle, you may opt for a multi-asset fund or having some mix of investments to create some short-term security while still allowing for growth.

I’ll be getting a boost in my retirement from inheritance, how do I factor it in?

If you can, allow inheritance payments to be a cherry on top rather than a significant slice of your retirement pie. Unless you are receiving a substantial lifetime gift now, it can be hard to know when you’ll receive something from an estate and how much.

It’s a good rule of thumb to plan with the money you have available now, not rely on the money you think you may receive in the future. This puts control back in your hands, and you can always spend more later if you find yourself with more. It’s much harder to cut back on your lifestyle if your plans hinge on something that doesn’t materialise.

You might also need to factor in tax. Although any inheritance tax might be sorted before you receive funds, it could reduce your share if it applies. If you are passed down unused pension funds, you’ll likely need to pay income tax when you use it if the person who passed away is over age 75, even if they were your spouse or civil partner. Read more about five pension inheritance tax issues families should plan for now

At what point is it worth speaking to a financial adviser?

Approaching retirement and accessing your pension(s) is one of the biggest transitions for your finances, so if you are feeling overwhelmed, getting help can give you peace of mind and can avoid costly mistakes in the long run.

You might not need to commit to the cost of a financial adviser: the government offers a free guidance service called Pension Wise, through MoneyHelper, where you can have a 45-to-60-minute conversation about your defined contribution pension options with experts. But what you’ll receive from Pension Wise will be guidance, not advice. While guidance is helpful, advice can recommend a specific course of action for you.