As you approach retirement, it’s natural to feel excitement when you think of the many possibilities ahead. After years of careful saving, this is finally the time to reap the rewards of a lifetime of hard work.
Data from PensionsAge reveals that 739,535 people accessed their pension for the first time in 2023/24, an increase of 4.8%.
If you’re considering joining this growing number soon, it’s first worth pausing and considering several factors before you make any decisions about accessing your pension.
Continue reading to discover five vital questions to ask yourself before you start drawing from your pension.
1. “What am I going to do with my pension wealth?”
One of the first things worth considering before you access your pension is how you plan to use the wealth you’ve accumulated over the years.
For example, taking a tax-free lump sum without a clear plan for the money could be unwise. Your pension is likely invested in a way that meets your long-term needs, in a tax-efficient environment.
If you withdraw a large portion of your wealth without a specific purpose for it, you’ll need to find a new home for this money, potentially one that isn’t as tax-efficient as your pension.
While you could hold it in an Individual Savings Account – which shields your money from Income Tax, Capital Gains Tax, and Dividend Tax – you can only deposit a total of £20,000 a year as of 2024/25.
Additionally, withdrawing funds during a period of market volatility could lock in any losses, reducing the overall value of your pot.
As such, it’s vital to think carefully about your short- and long-term goals for retirement. If you need the money for a significant purchase in the short term, such as long-awaited home renovations or a dream holiday, you may wish to withdraw only what you need.
If you don’t have any immediate expenses planned, leaving your pension wealth invested could allow it to grow further and remain protected from tax.
2. “How am I going to access my pension?”
When the time comes to access your pension, you typically have several options: taking lump sums, purchasing an annuity, or transferring it into drawdown.
Each choice has benefits and downsides, and the right option for you will depend on your personal circumstances and retirement goals.
Lump sums
If you decide to take your pension as lump sums, the first 25% is typically tax-free. Just remember that your fund must last for your entire retirement, and if you take too much of it in lump sums, you might run out of money before the end of your life.
Annuity
An annuity can provide a guaranteed income for a set period or for life in exchange for a portion of your pension savings.
This offers you some much-needed financial security and peace of mind during the next phase of your life, ensuring you’ll receive a regular income you can rely on.
However, a downside of buying an annuity is that you typically don’t have as much flexibility over your pension wealth.
Drawdown
Pension drawdown can offer you this flexibility, as you can draw funds as needed, giving you the ability to adjust your income each year.
This could help you manage your withdrawals in a way that avoids exceeding your Personal Allowance or triggering higher rates of tax.
However, with this option, your income isn’t guaranteed, and the value of your fund might remain susceptible to market fluctuations.
While it is important to consider which of the three options would best suit you, you might want to consider a combination.
For instance, you could take a lump sum at retirement to meet a one-off expense, benefit from the flexibility of pension drawdown at the start of retirement, and then purchase an annuity later in life when you start to slow down so you can deal with regular costs.
3. “Will I want to continue to contribute to my pension?”
Accessing your pension doesn’t necessarily mean you have to stop contributing to it. If you’re considering a phased retirement, for example, and wish to continue working part-time or in a consultancy capacity, you might want to continue boosting your fund from your earnings.
However, if you do, it’s vital to be aware of the Money Purchase Annual Allowance (MPAA).
In 2024/5 the Annual Allowance allows you to contribute up to £60,000 a year to your pension (or 100% of your earnings, whichever is lower) without additional tax charges. Your Annual Allowance may be lower if you are a higher earner.
Once you begin accessing your pension wealth, you may trigger the MPAA, limiting your tax-efficient contributions to £10,000 a year.
This significantly reduces the amount you can save to your pension in a tax-efficient way. So, it’s important to think about whether you want to flexibly access your pension and potentially trigger the MPAA if you plan to continue working in some capacity.
4. “Do I want to pass on some of my pension wealth to loved ones after I’m gone?”
If leaving wealth to your loved ones is a priority, your pension could be a valuable tool for mitigating tax.
Indeed, unlike many other assets, the wealth held in your pension is typically excluded from your estate for Inheritance Tax (IHT) purposes, making it an effective way of passing on wealth.
Just remember that if you pass away before the age of 75, your beneficiaries can usually inherit your pension free from tax. If you die after 75, your pension wealth can still be inherited, but your beneficiaries will usually pay Income Tax on it at their marginal rate.
Due to this, it’s worth considering whether you wish to leave your pension invested, which could mean it retains its tax advantages for your next of kin.
You may even find it beneficial to draw an income from other sources of savings or investments that are normally subject to IHT before accessing your pension.
5. “Am I going to seek professional guidance?”
The decision to access your pension is perhaps one of the more significant financial choices you can make in life. As such, it might be wise to seek professional help first.
Despite the many benefits of doing so, FTAdviser reports that nearly 70% of people who accessed their pension for the first time in 2022/23 did so without seeking advice.
By considering your income sources, outgoings, and how your spending needs might change, we can help you develop a bespoke retirement plan that ensures your withdrawals are sustainable and aligned with your goals.
Our professional guidance could even ensure that your pension wealth lasts longer. Indeed, a report from Standard Life found that people who work with a planner believe they can fund their retirement lifestyle for six more years compared to those who didn’t take advice.
Moreover, we could guide you in developing an income strategy that helps you manage your tax liability, ensuring you make the most of your available allowances and can pass as much wealth as possible on to your loved ones.
To find out more about how we can help you make vital decisions regarding pension withdrawals, please call 01992 500261 or fill in our online contact form to organise a meeting and we’ll be in touch.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
The Financial Conduct Authority does not regulate estate planning, cashflow planning, tax planning, trusts, Lasting Powers of Attorney, or will writing.
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