Pension Freedoms represented a major shift in the way you can take pension income. Coming in to effect in 2015, you now have the ability to withdraw as much of your pension as you like from age 55, and its popularity has been increasing ever since. In total, HMRC reports a staggering £17.5 billion has been withdrawn from pension schemes since April 2015.
Flexible withdrawals hit an all-time high in the second quarter of 2018 reaching £2.3 billion, an increase of 22% compared to the same period in 2017. It’s not just the value of withdrawals reaching new heights; the number of people making them has increased 32% on the previous year, with 264,000 people making 574,000 withdrawals.
In fact, the actual number of withdrawals have increased most compared to the second quarter of 2017, up 42%, meaning it’s become commonplace to make frequent withdrawals in a short timescale. Dipping into pensions is an occurrence expected to increase, as Andrew Tully, Pensions Technical Director at Retirement Advantage explains; “Many people are making multiple withdrawals in a tax year, which suggests they are treating their pension more like a bank account.”
That’s all good and well, but let’s remember that pensions were designed to provide for later life, replacing income from your working career. The intent wasn’t to use them as a savings account in your late 50s when you are likely to remain employed for another ten years.
What’s it being spent on?
According to Retirement Advantage data, the top three reasons for making pension withdrawals were
1. Moving money to a savings account (29%)
This might be a bit short-sighted… Savings accounts may be free of the investment risk associated with being invested in a pension, but with the Bank of England base rate at 0.75%, the interest received from a savings account is highly unlikely to exceed inflation, which is currently 2.5%.
You will benefit from quicker access to your savings, but it’s buying power will be eroded over time, having an adverse effect on your retirement income.
Furthermore, withdrawing a pension to put funds in a savings account isn’t a wise idea considering Inheritance Tax (IHT) planning; pensions are often exempt when calculating IHT, savings accounts are not! This arrangement may end up costing your beneficiaries more when you die.
2. Using it for home improvements (25%)
There is an argument to say that adding equity to your property is an investment. However, relying on downsizing or releasing equity for retirement is a risky tactic, as property is illiquid (meaning you typically can’t sell it quickly without a substantial loss in value).
Like savings accounts, property is also included when calculating IHT, so again, you could be costing your beneficiaries more and paying additional tax if you pass away.
3. Paying non-mortgage debt (18%)
Repaying debt is always sensible and should be a priority before retirement, but with low interest rates (and assuming you have a good credit rating), the interest payable on longer-term debt like personal and secured loans might be less than the growth your pension portfolio is achieving after charges. It is accepted that there are investment risk considerations here.
Short-term finance like credit cards and overdrafts, which are often much more expensive, should be repaid as a priority before retiring.
Incredibly, using pensions to pay a regular income, as they were intended, only rated as the fifth popular reason for taking income, with 14% stating it as the primary reason.
When making withdrawals 25% of your pension is usually tax-free, the remaining 75% is added to any other income you receive that year and is subject to income tax. The issue here, as Tully explains, is that “people are accessing their pensions at younger ages, certainly before state pension age.”
“The combination of taking multiple withdrawals in a tax year at earlier ages when people are still likely to be earning income from work means many are likely to pay more tax than if they took withdrawals more gradually.” It’s great news for HMRC, but not for your pocket.
What about the future?
It was recently announced by the Office for National Statistics that the UK has experienced one of the largest slowdowns in life expectancy among the world’s leading economies. This is naturally important when pension planning as you need to estimate how long you’ll need income for.
The problem is that even with an idling average life expectancy of 79 for men and nearly 83 for women, research from Aegon found that in order to provide an Annuity income, alongside your state pension, to make up an equivalent income of £28,000 p.a. from age 65, you would need to have saved a pension fund of £612,700! The Annuity rates their calculation is based on are currently low, which does have an impact, but that’s an incredible sum of money and wildly unrealistic for many.
Even intending to live on a more modest Annuity equivalent to £18,000 a year when including state pension income, the same research suggests a pension fund of £301,500 is required. The likelihood of achieving these figures, whilst making withdrawals to spend on home improvements, may be a challenge that requires considered planning.
What should you do?
There is no substitute for quality, realistic, financial planning. If you would like to better understand your pension, retirement goals and plan towards a secure financial future, we are here to help. Our approach to financial planning means that we build long-term relationships with our clients, long into your retirement.
We are here to support you through every stage of your financial journey, start yours now by calling us on 01189 876655.