For most people, their pension becomes accessible from the age of 55. If you’re nearing your 55th birthday, you might be tempted to make a withdrawal, whether as a one-off lump sum or regular income. However, using your pension as soon as you can, may have a greater effect on your retirement lifestyle than you anticipate.
If turning 55 is still some way off, keep in mind that the pension age will rise to 57 in 2028. However, the same considerations will still apply.
According to figures obtained from the Financial Conduct Authority, the number of savers accessing their pensions as soon as they hit retirement age is rising. Between 2017/18 and 2018/19, the number of people doing this increased by 10%. In the second quarter of 2019, a record 7,683 people aged 55 accessed their pension. Since the pension shake-up in 2015, those aged 55 have withdrawn £7.5 billion from their pension.
From the age of 55, you’re able to access your pension in a way that you choose. You don’t have to do anything with your pension when you reach retirement age, you can leave your money invested until you need it. However, should you decide to access it, your options are:
- Purchase an Annuity: If you have a Defined Contribution pension, purchasing an Annuity is the only way to create a guaranteed income for the rest of your life. It’ll pay out a defined amount and may be linked to inflation. The earlier in your life you take out an Annuity policy, the lower the rate you will receive, reducing retirement income. Purchasing an Annuity is a decision that can’t be reversed, so it’s important to ensure it’s the right choice for you.
- Use Flexi-Access Drawdown: With Flexi-Access Drawdown, your pension is invested. However, you’re in control of how much you withdraw and when. You can chose to take a regular income with this method or withdraw lump sums as and when you need to. You can take 25% of your pension tax-free, the remaining 75% is taxable. This can either be as a one-off lump sum when you first access your pension or taken off smaller amounts over time.
- Take your pension in one go: It’s possible to withdraw your entire pension in one go. However, this isn’t appropriate for the majority of people and tax rates can be significant.
But just because you can access your pension, doesn’t mean you should. Here are four things to keep in mind before you decide.
1. Considering longevity
The earlier you access your pension, the more it must stretch to last for the rest of your life.
Over the last few decades, life expectancy has increased. If you’re approaching retirement in 2020, you’re likely to spend far longer in retirement than previous generations. The Office for National Statistics life expectancy calculator gives you an idea of how long your pension may need to last for:
- If you’re a woman aged 55, the average life expectancy is 87. However, you have a one in four chance of reaching 94
- If you’re a man aged 55, the average life expectancy is 84 and you have a one in four chance of celebrating your 92nd birthday
If you start making withdrawals at 55, there’s a good chance your pension needs to deliver an income for over 30 years, in some cases for more than 50. Accessing your pension at 55 can provide you with more opportunities but you need to keep longevity in mind and the impact this will have on your income in your retirement years.
2. Impact of withdrawing a lump sum
A tax-free lump sum at the age of 55 can be incredibly useful. It may help you clear remaining debts, such as your mortgage, or meet goals you’ve been looking forward to.
For many people, taking the tax-free lump sum doesn’t mean they start making regular withdrawals from their pension. In fact, around 45% that access their pension take just the tax-free cash. Just two out of five starts drawing an income immediately.
Separating when you take the tax-free lump sum and withdrawing an income can be prudent. But you still need to make some calculations before you proceed.
Taking a lump sum out of your pension at 55 could have an impact on your retirement income in the future. This is money that would otherwise be invested and, hopefully, delivering returns. As a result, the impact can be more significant than you first think. Many people find they’re still able to achieve their retirement income target after taking a lump sum, but checking can give you peace of mind.
3. Reduced pension annual allowance
At the age of 55, you may still be planning to work for several years after first accessing your pension. You may also plan to continue contributing to a pension during this time. However, the Money Purchase Annual Allowance (MPAA) may limit how much you can add.
Once you access your pension beyond the pension commencement lump sum, the MPAA will be triggered. This reduces the maximum you can tax-efficiently contribute to a pension to just £4,000 per tax year. This limit covers employer contributions and tax relief too.
If you haven’t planned for the MPAA, you may struggle to get your pension value to where you want it at the point of retirement.
4. The tax consequences
If you choose to access your pension at 55, the chances are you are still working and could be for many years to come. Beyond the 25% tax-free lump sum, withdrawals are considered income, as a such they may be liable for Income Tax.
If you’re currently employed, additional income from your pension could push you into a higher tax band. As a result, making a withdrawal could mean you pay more tax than anticipated. If the additional income isn’t needed, leaving the money in your pension is more efficient. Where a pension income is needed, it’s important to understand your tax position.
Taking greater control of your pension
If you’ve taken a hands-off approach to saving for retirement, it’s time to take greater control of your savings. The introduction of Pension Freedoms in 2015 mean that retirees have far more responsibility for their income than previous generations. Being engaged with your pension and the decisions you’re making can help you make the most of your saving to build the retirement lifestyle you want.
Taking control of your pension can be daunting and you may be unsure about your options. Luckily, you don’t have to do it alone. We’re here to help you get to grips with the retirement decisions you face, including whether you should access your pension at 55. Call us today to arrange a meeting with a financial planner to go through your options.
Please note: 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 the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on individual circumstances, tax legislation and regulation which are subject to change in the future.
