Published On: Thu, Apr 11th, 2024

State pension warning as savers rush to make record pension withdrawals AGAIN | Personal Finance | Finance

2015’s pension freedom reforms scrapped the obligation to buy an annuity at retirement, putting people in control of their retirement pots. Savers can start making withdrawals as soon as they turn 55.

Growing numbers are doing this but risk draining a pot of money that is supposed to last for another 30 or 35 years.

Three in four retirees now leave their pension invested via drawdown, which allows them to make lump sum or regular withdrawals to top up their state pension.

Now a pensions expert is warning that many risk depleting their retirement savings by taking “too much, too soon”, and we are now entering the danger zone.

April, May and June is “peak withdrawals season” as savers use their new tax allowances, which came into force from April 6.

During the same three-month period last year, 567,000 pension savers took a record £4billion of taxable pension payments, drawing £7,100 each on average.

That was a rise of 17 percent and Tom Selby, director of public policy at AJ Bell, said pension withdrawals could break records yet again this year as the cost-of-living crisis drags on.

“While inflation is now cooling, the pain of two years of rising prices is still being felt by households, and many prepare to remortgage in a world of much higher interest rates.”

Raiding pension savings to plug any shortfall is tempting but has worrying long-term consequences. Nobody wants to end up scraping by on the state pension alone. But that’s what will happen if you’ve blown your own pension savings.

Selby urged pension savers to take steps to reduce the risk of running out of money in retirement.

His calculations suggest that a 55-year-old with a £100,000 pension pot who withdrew £5,000 a year would run out of cash by 80. This assumes their fund grows four percent a year after charges, with inflation averaging two percent.

If their pension grows at a slower pace (or even falls in a stock market crash) or inflation is higher, they could run out of money even sooner.

It is important to remember that any pension withdrawals will be added to your total earnings for that year, and will be subject to income tax. If you make withdrawals while still earning income from a job, the money could be taxed at a higher rate.

Selby warned of another downside. “By taking pension early you miss out on all future investment growth on that money.”

Early pension withdrawals will also shrink your ability to put money money into a pension in future, he added. “Taking even £1 of taxable income from your pension flexibly will trigger something called the money purchase annual allowance (MPAA).”

This slashes the annual allowance – the amount you can invest in a pension each year and claim valuable tax relief – from a maximum £60,000 to just £10,000.

Selby said: “If you trigger the MPAA you will lose the ability to ‘carry forward’ unused pensions allowances from the three previous tax years.”

He said if you do need to draw money from your pension, consider taking your tax-free cash. This doesn’t trigger the MPAA.

READ MORE: Drawdown disaster looms as Britons deplete savings by making record pension w…

“Alternatively, you could cash in smaller personal or occupational pensions worth £10,000 or less without triggering the MPAA, provided you exhaust the entire pot in one go.”

One big advantage of pensions is that they can be passed on to loved ones free of inheritance tax (IHT).

If you die before 75 there is no tax charge at all. However, if you die from age 75, your beneficiaries may have to pay income tax on the money, at their marginal rate.

Selby said: “For those who want to leave assets to loved ones, it often makes sense to leave as much of your pension untouched as possible in order to minimise your IHT bill.”

Many therefore prefer to fund their retirement spending from other savings, including tax-free Isas, which are free of income tax and capital gains tax, but liable to IHT.

He added: “For those who want to pass their pension to loved ones, it’s also important to ensure your nominated beneficiaries are up to date so the right people inherit your pot.”

Pension freedoms allow people to manage their own money. But they have also liberated them to make costly mistakes they may later regret.

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