A decade after Pension Freedoms were introduced, people are enjoying increased flexibility in how they can access their retirement savings. But with the changes also come challenges.
Introduced in April 2015, Pension Freedoms essentially opened up a raft of new options for those with defined contribution (DC) pensions.
Now that the first cohort of people able to access their pensions under Pension Freedoms are approaching State Pension Age, we can look back over the first 10 years to understand the benefits and challenges these new rules have presented.
A decade of positive change mixed with potential pitfalls
Research from Standard Life suggests that, for the most part, the reforms have been received in a good light. Their findings show that 84% of people believe they’ve benefited from taking money from their pension, while 79% liked having the choice to access their money in the way they want to.
Conversely, Standard Life also cites separate research from the Pensions Policy Institute, which found that 41% of retirees will be at a high or medium risk of making poor decisions in the future.
With this in mind, here are three key lessons we could learn from 10 years of Pension Freedoms.
1. Consider when you need to access your pensions
Data from Royal London explored the landscape 10 years on, uncovering the choices people made with their newfound freedoms.
Regarding the tax-free lump sum, findings show:
- 8% of people took it within six months of their 55th birthday
- 26% deposited it in a bank or savings account
- 19% used the money for home improvements
- 8% gave it to family members.
However, tempting as it may be to withdraw cash as soon as you can, it’s a good idea to exercise some caution. Taking 25% will immediately reduce the value of your pension pot, which in turn means you’re effectively reducing your future potential level of retirement income.
You’re also limiting any opportunities to further grow this part of your pension through your investments. In fact, according to Fidelity International, as an example, if your pension is worth £80,000, you could take £20,000 tax-free.
While growth is not guaranteed, if you instead left all the money invested and it grew at a rate of 5% a year over 10 years, your pension could be worth £124,000.
At this point, you could take out your 25% lump sum, which is now worth £31,000 tax-free. So, that’s an extra £11,000 your money will have accumulated by you delaying your lump sum withdrawal.
2. Explore tax-efficient ways to draw from your pension
Tax efficiency is a key consideration in retirement. Yet, the Royal London data shows that only 37% of people with a DC or personal pension considered whether taking a lump sum would mean they paid more tax or moved into a higher tax bracket.
Also, 55% of people eligible to take a tax-free lump sum took the whole amount at once.
So, it’s worth considering tax before you begin drawing from your pension. For example, you can spread your tax-free lump sum out over time and across tax years, which can help you take a tax-efficient income over time. However, if you take it all at once, you lose this option.
Any pension withdrawals you make above your tax-free allowance are also potentially subject to Income Tax. So, making tactical withdrawals and carefully structuring your pension withdrawals during retirement can ensure you make the most out of your fund.
Worth remembering before you take out your lump sum is that pensions are eligible for tax relief while you’re saving for retirement. Any growth in your pension fund is also tax-free.
Additionally, as you can withdraw your lump sum from age 55, you might still be working and receiving a salary. This means that any taxable funds from your pension are added to your earnings for tax purposes.
Even if you’re not already a higher-rate taxpayer, your pension income could tip you into this category.
You may also need to consider the Money Purchase Annual Allowance (MPAA) if you access your pension while still working.
You may trigger the MPAA if you withdraw more than your lump sum, meaning your Annual Allowance – the amount you can tax-efficiently pay into your pensions each tax year – falls. In 2025/26, the Annual Allowance is normally £60,000 (or 100% of your earnings, whichever is lower) but if you trigger the MPAA it will be reduced to £10,000.
This could make it more difficult to build wealth in your pension tax-efficiently.
3. Seek professional advice before accessing your pensions
According to Royal London, 42% of those aged over 50 were worried about running out of money during retirement. However, just 39% of people spoke to a financial adviser before accessing their pension wealth.
The rules around Pension Freedoms are complex and complicated. Considerations such as your age, life expectancy, aspirations, and family circumstances all play a part in deciding when to access your pension and how much to draw, along with the actual size of your pension funds.
The tax implications can also be either misunderstood or completely overlooked, and you could end up reducing your retirement income for when you need it most.
A financial planner can help you understand your choices and work with you on an individual basis. It could be that taking a portion of your tax-free lump sum is actually the right move, especially if you have immediate costs or would like to clear some debts.
Alternatively, you might not need the entire 25%, and your financial planner can make sure you’re covering your costs without unduly impacting your future funds. They can also help you to design your overall retirement income strategy, so you use your pension to best effect to achieve your goals.
Get in touch
We’ll be happy to talk to you about any aspect of pension or retirement planning based on your specific needs. 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.
All information is correct at the time of writing and is subject to change in the future.
HM Revenue and Customs’ practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
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.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.
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.
Approved by the Openwork Partnership on 21/05/2024
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