It’s a wonderful feeling when you approach your savings goal and can begin thinking about how and when you might retire.
Whether you’re planning to travel the world, spend more time with family, or explore new hobbies, you’ll likely rely on your pensions and other savings to fund much of your lifestyle.
You may need to think carefully about how you draw from your retirement pot, especially your pensions, to ensure that you don’t spend your savings too quickly. Additionally, there could be certain tax implications to consider.
These factors are becoming increasingly important as the amount that savers are taking from their pensions is on the rise. Indeed, Which? reports that pension withdrawals increased by 20% in 2023/24.
If you’re planning to access your pensions for the first time soon, here are three important questions to ask yourself first.
1. Is now the right time to access my pension?
Normally, you can access your private and workplace pensions from age 55 (rising to 57 in 2028). This is known as the normal minimum pension age (NMPA). However, depending on your situation, you don’t necessarily need to access your pensions as soon as you reach the NMPA.
If you’ve retired at this age, you will likely need to generate an income from your retirement savings to fund your lifestyle, so you may decide to access your pensions.
However, you may want to think about whether you really need to draw from your pensions yet or if you can rely on wealth from other sources. For instance, you may have income from a rental property or consultancy work. Additionally, you could draw on cash savings to fund your lifestyle before accessing your pensions.
Funding your lifestyle with wealth from other sources means you could leave your pension savings invested for as long as possible and potentially generate more growth.
If you do need to access your pensions, it’s important to consider how long your savings are likely to last if you maintain your current standard of living. Drawing from your pensions too early could mean that your savings run out part way through your retirement and you may have to make sacrifices to your lifestyle.
Fortunately, you could avoid this if you carefully consider how much you can afford to withdraw from your pension each year.
Continue reading to learn more.
2. How much can I afford to withdraw?
When you start accessing your pensions, it’s important that you make sustainable withdrawals so you don’t deplete your savings too quickly.
Unfortunately, this is a common issue for many retirees. Indeed, according to the Actuarial Post, more than 220,000 UK pension pots had an annual withdrawal rate of 8% in 2023/24.
If you started drawing 8% annually from a £200,000 pension pot at age 65, you could have nothing left by age 82. This assumes 5% annual investment growth.
As life expectancies increase, this might mean that you have a decade or more of retirement left without any pension savings.
Yet, if you reduced your withdrawal rate to 6%, your pension savings would last until around 92, and if you only took 4% annually, you would still have £184,000 left at 100 (assuming the same 5% annual growth rate).
That’s why it’s important to create a retirement budget and determine what level of income you need to cover your living expenses. You can then calculate how many years you might be able to fund your lifestyle for before your pension savings run out.
We can use cashflow planning to help you make these calculations, taking factors such as inflation into account. This ensures that you only take what you need from your pensions, and you can maintain your desired lifestyle for as long as possible.
Limiting the amount that you draw from your pensions could also help you reduce the tax you pay in retirement.
3. What tax could I pay when drawing from my pension?
If you pay more tax than you need to when drawing from your pensions, you could deplete your savings faster than expected.
Normally, you can take the first 25% of your pension as a tax-free commencement lump sum, up to the Lump Sum Allowance (LSA) of £268,275.
Withdrawals you make from the remaining 75% will be taxed at your marginal rate of Income Tax if they exceed your Personal Allowance of £12,570 in 2024/25.
As prices rise, you may have to draw more from your pensions in the future to maintain your current standard of living. Unfortunately, the Personal Allowance remains frozen until 2028, which could mean that more of your income exceeds the threshold, and you pay more tax.
This is why PensionsAge reports that 3.1 million pensioners could be dragged into the higher- or additional-rate tax bands by 2027/28.
In comparison, drawing income from savings in an ISA won’t attract Income Tax. As a result, you might benefit from using these savings first and leaving your pensions untouched for as long as possible.
If you do need to access your pensions, it’s important to budget carefully and only take what you need to fund your lifestyle each year. This could allow you to limit your taxable income as much as possible.
Additionally, you’re able to take your tax-free lump sum in instalments, and many providers let you draw from the tax-free and taxable portion of your pension at the same time. This creates opportunities to be strategic with the tax-free cash from your pension.
For example, you could take £1,000 a month from your tax-free lump sum and another £1,000 from the remaining 75%.
This gives you an annual income of £24,000, but only £12,000 comes from the taxable portion of your pension. As such, you won’t pay Income Tax on your pension withdrawals because you remain within your Personal Allowance (provided you have no other taxable income).
Bear in mind that this strategy only applies until you have used your tax-free lump sum, but it could be an effective way to mitigate tax at the beginning of retirement.
Also, you won’t pay Income Tax when withdrawing savings from an ISA. So, if keep your pension withdrawals low and supplement your income with ISA savings, you may be able to significantly reduce the tax you pay.
It’s important that you consider the most tax-efficient ways to draw from your retirement pot, and we can support you with this.
Get in touch
If you plan to access your pensions for the first time soon, we can help you answer these key questions.
Please give us a call on 01276 855717 or email info@braywealth.com today.
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 value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
HM Revenue and Customs’ practice and the law relating to taxation are complex and subject to individual circumstances and changes, which cannot be foreseen.
The Financial Conduct Authority does not regulate cashflow planning or tax planning.
Approved by the Openwork Partnership on 31/10/2024
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