Retirement savers have had more choice about how they spend the money in their pensions for more than two years, but not everyone understands how pension freedoms work.
Often the problem is making financial decisions in the wrong order, which can lead to costly risks and potentially paying too much tax.
Rather than taking the money without a clear idea of what you are going to do with the cash, think carefully before making any withdrawals.
Don’t forget there are no hard and fast rules as everyone’s finances are different, but you need to have a plan for funding your retirement if you want to make the best of the time.
The questions to ask about money. Try thinking about these questions before you touch your pension pot.
How much pension cash have I got?
Work out a cashflow covering all your pensions – the state pension, any workplace pensions and any private schemes.
It’s likely the pensions will start at different dates, so the full amount is not available until when the last pension pays out.
Consider any age gap between you and your partner that might mean your income is boosted by an extra salary until retirement and how losing this money impacts your income.
What do I need the money for?
One of the major pension freedom mistakes is people taking their pension cash and simply leaving it in the bank. Doing this means the money loses investment growth as the return in the bank is likely to be far less than the compound interest applied in the retirement fund.
Tax is also an issue because that money paid to HM Revenue & Customs could also be growing in the pension fund.
How much tax will I pay?
Arranging your finances to pay the least amount of tax is a vital part of retirement planning.
You do not have to take your tax-free lump sum to minimise tax, because if you stop working you still have a £11,500 personal allowance which you can utilise by drawing money from a pension.
Also think about taking ISA cash before money from pensions, as ISA withdrawals are tax-free.
What are the risks?
The risks depend on the type of pension.
If you have a direct benefit scheme with an employer, the risk is the company going bust or being taken over and the Pension Protection Fund taking over the payments. If you are yet to drawdown, you could lose 10% of your expected benefits.
If you have a direct contribution scheme, which can be a workplace or personal pension, income is based on fund value. Should you have risky investments in the hope of increasing returns or should the market collapse around your retirement date, you could see your fund reduce or even wiped out.
Any rise in the cost of living could also impact pensions that are not index-linked as they will not increase with inflation.
How long will my money last?
This depends on your burn rate – the speed at which you spend the money – and how long you expect to live.
Going on a spending spree and then expecting the state to take up the slack with benefits is a risk, as local councils have ‘deprivation of capital’ rules blocking benefit payments to people who do this.
You probably need to think about personal wealth rather than just pensions to fund retirement. This could include equity release from a home, investments and other savings.
What are my pension options?
Pension freedoms have given more people better choices about how to spend their money.
The first step is shopping around for the best deal because the company providing your pension may not be the best place to keep your money once you start withdrawing cash.
Here are the options for withdrawing money from a pension fund:
- Leave the money invested in the pension
- Drawing all the money in one go
- Drawing money in regular payments
- Drawing money when you need a top-up
- Buy an annuity that offers a guaranteed income for life
- A pick-and-mix of all the options
See Pension Freedoms Explained for more information
When can I take my pension cash?
Many pensions start paying out when you reach the age of 55 – but not all, so you need to find out the pay date for each scheme.
If you have a public sector or civil service pension, they typically start when you reach 60 years old.
The state pension pays at 65, but this rises to 66 years old in October 2020 and further increases are scheduled between 2026 and 2028.
Other workplace or private pensions may make retirement savers wait until they are 65 years old before they can access their cash.
The pension advice rule
If you have one or more UK pensions with funds adding up to £30,000 or more, you will need to take guidance from a free service like Pension Wise or consult an IFA about your pension options before you can withdraw any money.
QROPS and pension freedoms
The government has cleared QROPS offshore pensions for expats to follow pension freedoms in the same way as UK onshore pensions.
However, few overseas providers offer the same pension options as those available in the UK.
Malta QROPS providers can choose to offer the options, while those in Gibraltar, Guernsey and the Isle of Man are looking to introduce pension freedoms.
Expats can start taking money from a QROPS at the age of 55.