New data from the Financial Conduct Authority (FCA) has found that only around half of people accessing their pension savings took advice or guidance. Just over a third (37%) of people sought regulated advice, while a further 15% received guidance from Pension Wise.
Worryingly, three in five people (62%) who fully withdrew their pension pot did so without taking advice, which could’ve resulted in a significant income tax bill
Writing in Money Marketing, pension expert Rachel Vahey says: “It’s clear far too few people are seeking advice or guidance about crucial retirement decisions across the board.”
As accessing a pension without professional advice can have adverse consequences, here we outline three things to consider when the time comes to access retirement savings.
1) The possibility of running out of money in later life
Research has found non-advised clients taking income directly from their pension using ‘drawdown’ are three times more likely to run out of money when compared to clients who took advice.
New analysis from data provider Moneyfacts compared the sustainability of withdrawal rates between advised and non-advised clients in the third quarter of 2019. It shows there are some differences between the rate of withdrawals based upon whether advice is being given or not.
Overall, 74% of people are taking more than 4% of the fund value each year. This contrasts with guidance from the Institute and Faculty of Actuaries, which suggests that 3% would be a more suitable drawdown rate for a 55-year-old, and 3.5% for a 65-year-old.
A greater percentage of advised drawdown customers (33%) are taking less than 4% of their income annually, compared with 28% of non-advised drawdown customers.
The survey suggests that non-advised drawdown clients are more likely to deplete their pension fund, although whether this is a deliberate strategy or unintentional is unclear.
Data from the FCA paints a similar picture. FCA figures examine withdrawal rates from income drawdown plans and reveal that withdrawal rates of 8% or more are the most common rates (except for the largest pots of £250,000 and above – where the most common rate was between 2% and 4%).
One other factor to consider is that over three-quarters of people fully withdrawing their pension savings are under State Pension age. This suggests that the money is to be spent now rather than used to meet income needs in later life.
One of the roles of a professional adviser is to ensure that income remains sustainable throughout retirement. By considering savings, investments and assets and an individual’s plans for their retirement, they can create a bespoke plan that maintains the level of income a person needs to achieve their standard of living.
As this research shows, simply taking a pension pot without advice means an individual can be up to three times more likely to run out of money in later life.
2) Paying less tax
In the 2018/19 tax year, just over 645,000 pension plans were accessed – to buy an annuity, move into drawdown, or take a first cash withdrawal. And, figures show that more than half (55%) of these plans were fully withdrawn.
We have already seen that taking the entire pension pot as a lump sum might mean that a person runs out of money in later life. Another reason to be wary of taking a pot in its entirety is that there could be a significant tax liability.
When an individual starts drawing benefits from their pension scheme, they can typically take part or all of the pension benefits as a tax-free cash lump sum (often known as the ‘pension commencement lump sum’ or PCLS).
As a member of a defined benefit (final salary style) pension scheme, the scheme’s rules will determine how much an individual can receive as a PCLS. If someone is a member of a defined contribution (DC) pension scheme, they will normally have the option to take up to 25% of the value of the pension pot as a PCLS.
Any amount that is taken as a PCLS is free of all taxes when it is paid. However, while members of defined contribution pension schemes have complete flexibility around how they can draw down their remaining pension pot after taking any PCLS, these amounts withdrawn will be taxed as income.
Any amount taken as a lump sum above the PCLS is added to an individual’s total income for that tax year. It means that someone withdrawing the whole, or a large part, of their pension pot could easily be pushed into a higher tax bracket and end up paying a marginal rate of tax of 40% or even higher.
In addition, not only may an individual pay tax on their lump sum withdrawal (if it’s above the allowable 25%) but they may also be overcharged by HMRC, which will levy an emergency tax charge. This overpayment can be reclaimed, but it is better to avoid paying it in the first place.
Again, a professional adviser will be able to look at your overall tax position and make recommendations for how you access your pension savings.
3) The ‘wrong’ assets could be used for income
2019 research from the Department for Work and Pensions showed that, for the average pensioner couple, more than 25% of their income came from ‘non-pension’ sources. Investment income and earnings from employment and self-employment play a key part in the financial plan of many retirees. We discussed how retiree’s income is made up in a previous article.
Simply accessing pension savings at retirement may not be the most efficient way of structuring retirement income. Using other assets first can have advantages such as:
- Leaving pension savings in an income drawdown scheme at retirement means that any investment growth will benefit the portfolio. And, it is not taxed unless or until the money is withdrawn as income.
- It can reduce the amount of Inheritance Tax (IHT) payable. Beneficiaries either pay no tax on what is left over in a drawdown scheme if the owner dies before age 75, or their normal tax rate if they are 75 or over.
These advantages won’t apply to everyone and it’s important to consider an individual’s circumstances before determining the most suitable income withdrawal strategy.
A financial planner can look holistically at an individual’s overall situation, taking into account their pension savings and other assets. They can then devise a sustainable withdrawal strategy that ensures a person maintains their chosen lifestyle in a tax-efficient way, while considering other issues such as inter-generational planning.
If you are approaching retirement and you need advice on how to structure your income, and what to do with your pension savings, please get in touch.
This article is distributed for information purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Ermin Fosse and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Ermin Fosse’s services.
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