The cost of living crisis has reportedly led to many individuals accessing large sums from their pension pots. HMRC figures show that money withdrawn from flexible pensions increased by 15% in the 2022- 23 tax year to £12.9 billion.
There are a wide number of factors to consider when it comes to drawing down from a pension. These include the stage you are at in your working/retirement journey, your health and life expectancy, the size of your pension and your overall investment portfolio. Here we discuss some of the issues when it comes to drawing down from a pension and look at what sustainable access may look like.
Whilst flexi–access drawdown has created greater flexibility for pension holders and retirees, in turn it has placed the responsibility of income sustainability on the individual to ensure the pension will last their lifetime.
In the past, a sustainable withdrawal rate of 4% per annum was a general rule of thumb to ensure funds lasted throughout retirement. However, recent figures have suggested that some pension holders are accessing their pension pots earlier and at much higher percentage rates, therefore risking their financial security in the future.
For a moderately sized pension of £500,000, 4% per annum equates to £20,000 gross a year – a figure that may fall below the current costs required for everyday living. This is where it may be tempting to increase withdrawals. However, by even adding one or two percent to your annual withdrawal rate, the duration for which a pension may last is likely to be substantially shortened.
With so many people feeling the pinch, those over 55s that are still in work may even feel the need to access their pension, perhaps several years before they had intended to. Such individuals may not be aware that as soon as you take any income from the pension pot for the first time, the money purchase annual allowance (MPAA) comes into play (accessing tax-free cash only does not trigger the MPPA). These rules put a limit on how much you can put into a pension each year once you’ve flexibly accessed it. The MPAA was increased on 6th April 2023 from £4,000-£10,000. However, those that are still working and may want to continue to save into a pension in future years could be shocked by the limited amount they are able to pay into their pension going forward.
There is also a lack of knowledge around the area of annuities. New research by Standard Life has discovered that half of the over 50’s don’t fully understand how annuities work. An annuity is purchased with a pension fund or a capital sum and gives you a fixed annual income during retirement in the form of regular payments for the rest of your life, regardless of how long you live. Because inflation and interest rates were so low for such a long time, this meant annuity rates represented poor value and they subsequently fell out of favour for many years. However, in the current economic environment of higher interest rates and inflation, annuity rates are now much more attractive and are worth a serious consideration for some.
Building a pension pot within the rules is one thing, but the picture becomes arguably more complicated when it comes to accessing it. Seeking advice from a financial adviser who can explain the rules and ensure you are accessing a pension at a sustainable rate can be hugely important for your long-term financial future.
To discuss any aspect of accessing a pension, or if you would like wider advice relating to pensions or financial planning, please get in touch.