Financial Planning

When You’re Tempted by Tax-Free Cash at 55

When You’re Tempted by Tax-Free Cash at 55

In 2015 the UK government introduced the new pension freedoms which allowed people to access their pension pots much more easily. Essentially, from this point, you could withdraw all of your pension in one go if you wanted to (although not without a tax penalty).

Lots of people were particularly excited about the fact that you could withdraw up to 25% of your pension pot as a lump sum, tax-free. With many pension pots in hundreds of thousands, that 25% often represents tens of thousands of pounds.

The temptation, of course, when you get your hands on that kind of money is to spend it. Think of the fancy car or luxurious holiday you could buy as a retirement present to yourself!

You need to be careful, however. Whilst we are certainly not against spending money on things you want to buy, withdrawing large sums of money from your pension pot can have some adverse consequences if you are not careful…


Emotion-based decisions

In June 2018 the Financial Conduct Authority published a report showing how people were using the pension freedoms. One of the findings was worrying – over a third of people took money out of their pension pots without seeking professional financial advice.

It seems that lots of people want to simply get their hands on 25% of their pension pots as soon as possible. This is understandable – you have worked hard throughout your life, and you want to start enjoying your retirement. Taking the time to weigh up your options about what to do with your pension pots can seem overwhelming and inconvenient.

Yet when you consider the impact a reckless withdrawal could have on your retirement lifestyle over the next thirty years or so, it makes overwhelming sense to take some time to make sure you are doing the right thing.

One important question you need to ask yourself is whether your current pension provider offers you the best deal for your desired retirement lifestyle and goals. Your present scheme might indeed be the best one to take an income from in retirement, but there could be a much better option out there waiting for you.

A financial planner will be able to help you ascertain whether or not this is the case. For instance, if you have an older pension scheme then it might not allow you to draw a flexible income in retirement (known as Flexi-Access-Drawdown). By switching to another provider you could increase your annual pension income by over 10%, depending on your circumstances.


Taking a look at the whole pot

Suppose you have £200,000 invested in your pension pot. Under the pension freedom rules, you could take out 25% once you reach the age of 55 – which represents £50,000.

This, of course, leaves £150,000 invested in your pension pot. How much income will this give you in retirement compared to if you had left the £50,000 invested?

For some people, it makes financial sense to take advantage of the 25% tax-free withdrawal and use the rest to buy an annuity (a guaranteed retirement income) or keep invested for income drawdown purposes. The 25% could perhaps be put towards paying off a large debt or making an important refurbishment on your home.

It’s a really good idea to flesh out these ideas with a financial adviser. Although consulting their advice is an additional cost, it can result in you receiving thousands or even tens of thousands more down the line in the form of extra income and tax savings.

One area where an adviser can provide a lot of value is to help you decide what to do with your tax-free lump sum, and then help you sift through some options regarding how to invest the rest of your pension pot to produce the best possible retirement income. Lots of people are invested primarily or only in cash, which provides a very poor return (especially when you factor in the eroding effects of inflation over time). A financial adviser will be able to help you diversify your investments so that they provide a higher return over a longer period, whilst minimising your exposure to risk in the event of market downturns.


Creating a sustainable retirement income

Did you know that over 40% of people drawing from their pensions are set to run out of money within eight years? That’s because they’re taking out about 10% of the value of their pension pot each years as a retirement income, which is completely unsustainable.

You obviously do not want to be in the situation of running out of money in retirement. This is why it is especially important to plan well ahead with regards to your pension income. Especially in light of the fact that we are all now generally living much longer – which means that your pension will likely need to stretch over a longer period.

How much money will you receive from the government as a state pension when you retire? What difference would it make to your retirement income to retire a few years earlier or later? How much do you have invested in your workplace pension(s), and what type of pension(s) do you have? Would you be able to afford a much more comfortable retirement income if you were to switch providers, or engage in a pension transfer?

These are the sorts of questions you need to ask yourself as your approach retirement, but they are difficult if not impossible to answer effectively alone. The rules about pensions, taxation and retirement income are complex and the laws frequently change. It can really help, therefore, to get an expert set of eyes on your financial situation and get you on track towards your goals.

If you are interested in starting a conversation with us about your retirement plans and goals, then we would love to talk with you. Please get in touch to arrange a free, no-commitment consultation with one of our friendly team members. We look forward to your call!

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