The coronavirus pandemic has led to financial hardship for many. For those over 55, the temptation to dip into pension savings might have proved too much.
A recent government report confirms that £2.4 billion was flexibly withdrawn from pensions in the last quarter of 2020, a 6% rise compared to the same period in 2019. The number of individuals accessing funds increased by 10%, to 360,000.
After an unprecedented 2020, turning to your pension savings might have seemed like the only choice, but the long-term consequences of altering your plans can be huge.
Here are five reasons why you shouldn’t let the pandemic alter your plans for retirement.
1. You’ll need to budget for much longer
The retirement plan you have in place considers your level of income, the size of your pension contributions, and your chosen retirement age.
Taking benefits from your pension early means you’ll need them to last longer.
The Office for National Statistics (ONS) confirms that the current UK life expectancy is 79 years for males and just over 83 years for females.
That means your retirement fund could realistically need to last you for another thirty or forty years.
2. You could limit your future contributions
If you access your defined contribution (DC) funds flexibly you could trigger the Money Purchase Annual Allowance (MPAA). This limits the amount you can contribute to the pension schemes you hold and still receive tax relief, stifling future pension growth.
The Annual Allowance for the 2020/21 tax year is £40,000 (or 100% of your pensionable earnings, if lower). This is the amount you can contribute to your pension while benefitting from tax relief. If you trigger the MPAA however, this amount shrinks to just £4,000.
You could be missing out on ten years of higher premiums, with added tax relief, and the compound growth of your larger fund.
3. You could end up paying more tax
Depending on the option you choose, you could receive up to 25% of your pension withdrawal tax-free, but the rest will be taxed as income. Taking large sums in one go could push you into a higher tax bracket meaning you pay 20%, 40%, or even 45% on portions of it.
Planning withdrawals carefully could help to mitigate the risk of a large tax bill, but with the Personal Allowance for the 2020/21 tax year at £12,500, adding pension income to your salary could mean exceeding a tax threshold.
You might also find you are emergency taxed. Taking an uncrystallised funds pension lump sum (UFPLS) means accessing all or some of your pension pot as a cash sum.
Although they are one-off payments, they are taxed on a ‘month 1’ basis by HMRC. This assumes the amount received is the first in a series of monthly payments, ongoing throughout the tax year, and effectively divides your Annual Allowance by twelve.
The result is that you will be overtaxed. This can be claimed back, but the process is time-consuming, and you will need to factor this into your decision if you are accessing your pension to cover an immediate shortfall.
4. You might need to work longer
Accessing funds while you are still working, potentially triggering the MPAA and becoming liable to increased levels of tax, could create a shortfall by the time your original retirement date arrives.
A Which? report from last year looked at the cost of retirement. It found that a retired couple looking to live a “luxury” lifestyle including world travel and a new car every five years would need £40,000 a year.
Depending on the type of lifestyle you plan to enjoy in retirement, you might find increased withdrawals now make your goals harder to achieve later in life.
You might have to work for longer or compromise on your standard of living in retirement.
5. There are benefits to leaving your pension until last
Pensions and certain savings products such as ISAs are tax-efficient. If you have other forms of income that you can use to fund your retirement you might be better off using these first, allowing your pension to grow.
There are also Inheritance Tax (IHT) benefits to having unused pension funds on death.
Unused pension funds don’t count towards the value of your estate for IHT calculation purposes. In the event of your death before the age of 75, you can usually pass 100% of your unused pension pot to your chosen beneficiary, tax-free.
Where death occurs after age 75, your beneficiary can still receive the proceeds of your unused pot, but they will be taxed at their marginal rate.
Get in touch
Despite the unprecedented nature of 2020’s economic challenges, the importance of sticking to your financial plans remains. Long-term investments based on long-term goals stand the best chance of allowing you to live your desired lifestyle in retirement.
If you have been tempted to make withdrawals from your pension earlier than originally planned, we might be able to help you find other ways to manage your current budget.
We can help you manage your retirement income so please get in touch. Email at email@example.com or call 0800 0787 182.