The 2015 freedoms made it much easier for people in defined contribution (DC) pension schemes to access their pension savings from age 55. As a result, most now choose either to remain invested at retirement, withdraw all their money as cash or combine the various options in some way. A fifth of people access their pension when they turn 55, according to Legal & General, which said 10% of those savers take their entire pot.
Almost 900,000 people accessed their pension savings for the first time in the 2023/24 tax year, according to the most recent data from the Financial Conduct Authority. The figure was up nearly a fifth on the previous tax year, while the overall value of the money withdrawn from pension pots over the period increased by more than a fifth to £52.1m.
But it warned that more people are accessing their pension savings without taking advice – putting them at risk of making very expensive mistakes. One wrong move can create a permanent dent in your retirement income. Here are the five things you need to consider.
Understand the tax implications
One option is to take your entire pot as a lump sum – but for many people this has come with an unexpected and painful sting in the tail. That’s because most withdrawals from a pension count as income, which is taxed in the same way as your salary. So while 25% of every withdrawal is tax-free, the rest is taxed at your marginal rate. In addition, many over-55s are still working, which means a lump sum withdrawal could push you into a higher tax bracket.
Until now, savers have had to apply for a refund from HMRC, which in the final quarter of 2024 alone repaid almost £50m to people who overpaid tax when flexibly accessing their pension. Total repayments since the freedoms began total nearly £1.4bn. If all those affected had applied for a refund the figure would likely be much higher.
The good news is that HMRC has now taken steps to prevent this from happening, by replacing the emergency tax codes used on pension lump sum withdrawals with regular tax codes which should ensure the right amount of tax is taken in real time. But you can protect yourself further by spreading withdrawals over several different tax years.
Make sure retirement savings last
Perhaps the biggest challenge is ensuring that your pension savings last as long as you need them to – rising longevity means your retirement could even be as long as your working life. This means you need to set any regular income at a sensible level or take care not to withdraw too much in lump sums – which is easier said than done. More than four in ten over 50s admit to worrying they could run out of money in retirement, according to a recent Royal London survey.
Another option is to use some or all of your savings to buy an annuity, which provides a regular retirement income (usually monthly) for as long as you live. Sales plummeted when the freedoms took effect, but have bounced back over the past year as the rates of return have become more attractive. Check out why you should be including annuities in your pension planning if you’re interested.
Consider risks around DB pension transfers
One of the biggest – and most worrying – trends in the years immediately following the reforms was a sharp rise in the number of people seeking to transfer their defined benefit (DB) pension schemes into defined contribution (DC) pensions in order to access the cash. Unfortunately, in doing this many people unwittingly sacrificed valuable guarantees and were hit by unexpected tax bills.
The FCA tightened the rules around transfers following a misselling scandal. For instance, you must now take financial advice if the pension’s transfer value is over £30,000. Even so, it’s a big and irreversible decision, so there’s a lot to weigh up. For instance, you need to consider if the transfer value being offered represents good value, and what guarantees you might be giving up.
Beware the pension scam epidemic
Unfortunately, the 2015 reforms presented opportunities to fraudsters as well as savers. Schemes aimed at using the new roles to separate people from their pension savings quickly proliferated, and pension savers continue to be targeted by too-good-to-be-true investment scams.
For example, pension liberation scams claim to give you access to your pension before age 55, the earliest point at which most people can legally take money from pension savings. They ask the target to transfer their pension into a separate scheme and then loan them back a sum from the fund, but they invariably take a huge fee, invest the cash in high risk assets and often leave victims with a nasty tax bill. Similarly, pension review fraudsters offer you a free pension review by a (typically unauthorised) company that wants to access the pension cash and invest it in unusual and high-risk assets. They promise very high or even guaranteed returns, which invariably don’t materialise.
You can protect yourself by never, ever accepting cold calls. Credible firms don’t phone people out of the blue or pressure them into making decisions. If you have any doubt over who’s calling, end the call. Also check the FCA’s ScamSmart website. It offers articles on different types of scams and information on what to do if you encounter or fall victim to a scam. They also have an up-to-date list of the organisations and scams to avoid. The FCA register also allows you to check if a particular firm is authorised.
It pays to take advice
Professional advice doesn’t come cheap. The average fee for advising on a £250,000 pension pot at retirement is £3,000, according to Unbiased. But it might be the best investment you ever make, given the potential complexities of managing retirement income. Advisers know all the possible pitfalls and how to navigate them. They can use specialist software to build a cashflow plan for your retirement, based on your circumstances, income needs and life expectancy. They’ll also create and manage an investment plan that is tax efficient and which is designed to ensure you never run out of money.
There’s a vast amount of resources available if you’re unable or unwilling to take advice, however. Most investment platforms and pension firms offer fund and portfolio recommendations. These are based on risk profiles, tools such as portfolio builders, risk questionnaires and various calculators. To compare platforms, including fees and charges, take a look at our free and easy-to-use platform comparison tools.
Photo by Isai Ramos on Unsplash
