Accessing pension funds early is not right for everybody.
In fact, without careful consideration, it could lead to financial difficulties later in life.
Data from Retirement Advantage shows that the amount people are taking from their pension has risen above the £6 billion mark, with £6.54 billion being withdrawn in 2017.
But, there are several mistakes that you could be making when withdrawing pension funds, including:
1. Taking too much too soon
78% of over-50s significantly underestimate their life expectancy (Source: Retirement Advantage). This means that, when planning how much to take out of your pension funds, there is a real risk of taking too much in the early days of retirement. Leading to financial difficulty in years to come.
2. Moving large amounts
It can be tempting to take large amounts, potentially even all your pension fund and place it in savings accounts (for example, Cash ISAs). That may be due to an inherent distrust of pensions, or due to a lack of information about interest rates.
After the age of 55, you can take up to 25% of your pension as a tax-free lump sum. Any further income is taxable. Therefore, why pay tax unnecessarily, only to get a 1–2% return from a bank account, which is currently guaranteed to be a real terms loss, if you consider the current rate of inflation?
3. Taking an inefficient income
Taking an income from your pension fund seems like the straightforward approach, after all, that’s what you have been saving toward. However, if you have other forms of savings, such as an ISA, it can be much more beneficial to use that capital as income instead.
If you take more than the Personal Allowance from a pension (most of which will be taken up by the State Pension), you will pay tax on it. So, it often makes sense to use your State Pension and other pension income to meet your Annual Allowance, then top up your income with money from your ISAs.
4. Failing to plan for IHT
Pension funds are exempt from Inheritance Tax (IHT), so any capital remaining when you die could be passed on to your spouse and children without tax. If you die before the age of 75, non-spousal beneficiaries may have to pay Income Tax, that may be less than IHT.
5. Not having a financial plan
A financial plan will help you to deal with all these issues; helping you to understand how much you can sustainably take from your pension, where you should be taking your income from and the part your pension plays in your estate planning.
Andrew Tully, Pensions Technical Director at Retirement Advantage commented: “The dash for cash shows no signs of slowing as significant sums continue to be withdrawn from pensions. A trend is emerging of pension pots being withdrawn fully, but there is insufficient information to tell us why. It could be that people are reacting to uncertainties in the economic environment or are simply worried about the legislative goalposts changing again, or they might just want their money.
“The freedoms have certainly generated a welcome windfall for the Treasury, but it’s clear tax has not been the natural brake to prevent people withdrawing large sums before retirement. We know people are accessing their pensions for the first time at younger ages, certainly before they are due to retire. And from our research we know they are spending the cash on making home improvements, going on holidays, paying off debts and saving the money outside of the pension.”
To discuss your pensions and how to effectively plan for retirement, get in touch with us.
Please note:
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Your pension income could also be affected the interest rates at the time you take your benefits. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
