Having spent decades saving towards your pension, you might be tempted to cash it in as soon as you can. Since additional freedoms were introduced back in 2015, many retirees have withdrawn benefits from the minimum age of 55 (rising to 57 in 2028).
Recent government figures confirm that flexible payments from pensions since flexibility was introduced now exceed £42 billion.
Last year, as the coronavirus pandemic left many struggling financially, the urge to access your pension might have been even stronger. In the last quarter of 2020, £2.4 billion was flexibly withdrawn from pensions, a 6% increase on the same quarter in 2019.
The long-term repercussions of accessing your pension earlier than originally planned can be severe.
You will often be better off leaving your pension until last if you can afford to. Here’s why:
1. You could push yourself into a higher tax bracket
Taking a large sum to cover immediate needs could push you into a higher tax bracket; you could get emergency taxed too.
Your Personal Allowance for the 2020/21 tax year is £12,500. Income over this amount will be liable to Income Tax. If you decide to start taking withdrawals, you’ll need to keep track of them – and your income from elsewhere – to prevent pushing yourself into a different tax bracket and receiving an unexpected bill.
Taking an uncrystallised fund pension lump sum (UFPLS) could mean you get overtaxed. Whether you take your whole fund in one go or opt for several UFPLS payments, each will be taxed by HMRC on a “month 1” basis.
This assumes the amount you receive is the first in a series of monthly payments and effectively reduces your Personal Allowance by eleven-twelfths.
You can claim this tax back, but the process can be time-consuming. You’ll need to consider this if you’re withdrawing money with a specific purchase in mind, especially a time-sensitive one.
2. You might trigger the Money Purchase Annual Allowance (MPAA)
You could trigger the MPAA if you take a taxable withdrawal from a defined contribution (DC) plan. This can make future pension saving harder.
The Annual Allowance for the 2020/21 tax year is £40,000 (or 100% of your annual earnings if lower). This is the amount you can contribute to a pension and still receive tax relief.
Taking advantage of certain pension freedom options could lower your Annual Allowance. Trigger the MPAA and your allowance drops to just £4,000.
If you want to access some pension funds early but also continue to contribute, you’ll need to be aware of the MPAA, as it could drastically reduce the amount you can save.
3. You’ll have to budget for a much longer retirement
In 2019, the World Economic Forum (WEF) calculated that retirees in the UK could expect to outlive their pension savings by more than a decade.
With average pension savings sufficient to last around eight and a half years from the date of retirement, UK males will on average have another ten years to live once their funds run out. The figure for females is just over twelve and a half years.
The WEF calculation was based on retirement at age 65. Whilst the State Pension Age for UK pensioners is now 66, the earliest you can take retirement is aged 55 (rising to 57 in 2028).
Based on current Office for National Statistics (ONS) figures, life expectancy is almost 80 years for males and over 83 for females. You could have another thirty or even forty years of life, post-retirement.
Ensuring you have sufficient funds for this length of time, and that you can budget effectively over a prolonged period, can be difficult. Speak to us as you approach your desired retirement date, and we can help ensure you have saved enough.
4. You might forgo the chance to pass unused pension pots to the next generation
There are different ways to pass your wealth onto loved ones. Using your pension is one of them.
The money you withdraw from your pension counts toward the value of your estate for Inheritance Tax (IHT) calculation purposes, but unused funds don’t. You can pass 100% of your unused pension funds on to the next generation tax-free, in certain circumstances.
Unused funds can be passed on to a chosen beneficiary, normally tax-free, if you die before age 75.
On death after age 75, you can still pass your unused pension funds on, but your beneficiary will pay Income Tax at their marginal rate.
If you expect to receive non-pension income in retirement, consider not taking your pension until you need to, and it might be available to pass on tax-efficiently.
Get in touch
Retirement is a massive life milestone, and as such, the decisions you make are crucial. The retirement option you choose, and how you fund that choice, could have significant long-term consequences.
If you are looking to retire soon, remember that there are benefits to not taking your pension yet, or at all. If you’d like to discuss your retirement, please contact us today.
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. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.
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