More retirees are choosing to take advantage of the Pension Freedoms open to them. While it provides a greater level of flexibility, it’s a move that needs to be balanced with the associated risks.
More than £2.2 billion was withdrawn from pensions during the second quarter of 2018, according to the latest HM Revenue and Customs (HMRC) statistics. It’s a figure that’s steadily been rising:
- In the second quarter of 2015, 84,000 individuals took a flexible payment from their pension
- This increased to 159,000 in 2017 and 200,000 in 2017 over the same three months
- In the second quarter of 2018, 264,000 people took advantage of their Pension Freedoms
What are retirees using Pension Freedoms for?
A Retirement Advantage survey found the 10 most common reasons for withdrawing cash from a pension were:
- Putting money in a savings account (29%)
- Using the money for home improvements (25%)
- Paying off non-mortgage debt (18%)
- Going on holiday (17%)
- Paying themselves a regular income (14%)
- Buying a new car (12%)
- Paying off the mortgage (11%)
- Gifting some money to children (8%)
- Helping family members get onto the property ladder (6%)
- Giving a gift to grandchildren (2%)
If you’re thinking about taking money out of your pension, there are some key areas to consider. Data from the Financial Conduct Authority (FCA) found that retirees are often making life-changing decisions without seeking professional advice.
- 63% of retirees purchasing a guaranteed income through an annuity don’t seek professional advice
- 30% of people taking money out of their pension to provide an income without an annuity do so without taking financial advice
- 5% of retirees accessing their money in this way did so without advice before Pension Freedoms
The changes to how you can access pensions bring both opportunities and threats. Those who use them wisely can take the opportunity to potentially retire earlier and mould the income they take to their retirement aspirations. However, if they’re used inappropriately, they could cause financial hardship in the future.
Four Pension Freedom risks to be aware of
To help you take advantage of the opportunities and avoid the treats, here are four risks to be aware of:
1. The dangers of holding cash
Before you take money out of your pension, you should have a clear idea of what you plan to do with it. If your plan is to hold your pension in cash, you may want to rethink your decision.
Of those consumers who don’t seek advice before taking money from their pension, a third keep the money withdrawn from their pension entirely in cash assets. The FCA estimated that half of these are at risk of losing out because of this strategy.
While keeping your pension in cash means money is not exposed to investment risk, inflation and low-interest rates mean it’s likely the value of the money will decrease in real terms. Conversely, those people who leave their money invested are likely to benefit in the longer term. In fact, this strategy could increase annual income by 37%, the FCA estimates.
2. Investment risk
Of course, on the flip side of your pension decreasing in real-term value, you have risks associated with investments.
Investing your pension can help it to not only keep pace with inflation but grow too in real terms. However, there’s also the risk that you may see its value fall, should the assets you’re investing in fall, for example. It could mean that your pension is worth less than the original amount.
Typically, the longer you’re investing for the more risk you’re able to take. But this is just a basic guideline, you may find that your situation allows you to take more risk or requires a cautious approach. If you’d like to discuss how investing your pension may affect your financial future, you can contact Balance: Wealth Planning today.
3. Increased tax
If you don’t already know about the tax implications of taking your pension, now is the time to learn.
You can take up to 25% of your pension fund tax-free once you’re 55. This portion of your pension doesn’t use up any of your Personal Allowance, currently set at £11,850, either.
You can access the remaining 75% from when you’re 55 too, but you may need to pay tax on this income. The amount of tax you pay will depend on your total income in that tax year and the level of personal allowance. Careful planning can help keep the amount of tax you pay to a minimum while giving you the income you need to support your lifestyle.
As a result, when you access your pension affects the amount of tax that you pay. Speaking to a financial planner before you take money from your pension could help you reduce the amount you’re taxed.
4. Running out of money
Life expectancy is rising and it’s likely you’ll be retired for at least 20 years, in fact, it’s not uncommon to spend 30, or even 40, years in retirement today. As a result, the pension fund you’ve built up needs to support you for a significant amount of time.
Underestimating how long you will live for and, consequently, the amount of money you will need to see you through retirement could leave you financially insecure in your later years. Over 50s are underestimating how long they are likely to live by up to six years, according to research from Retirement Advantage.
Choosing to take a lump sum from your pension, rather than using this money to provide an income, should be weighed up against the risk of running out of money.
If you want to discuss your retirement plans and how your pension can be used to reflect your goals, including using Pension Freedoms, please contact us.