AJ Bell has urged savers to ‘stop and think’ before accessing their retirement pot during peak withdrawal season.
Flexible pension withdrawals traditionally spike at the start of the tax year as savers take advantage of the new tax allowances.
This time last year saw a record £3.6 billion of taxable payments withdrawn from pensions flexibly during the second quarter, a jump of 23% compared to the same period in 2021.
With many Britons facing higher living costs as a result of surging inflation over the last 12 months, AJ Bell says withdrawals could hit fresh highs in April, May and June 2023.
However, head of retirement policy Tom Selby warned that it could have “disastrous consequences” if people take money too early or too quickly.
Selby said: “The start of the tax year is traditionally peak pension withdrawal season, with hundreds of thousands of savers dipping into their retirement pot – many for the very first time.
“With inflation remaining persistently high and millions of households facing eye-watering increases in housing costs, we are likely to see another surge in pensions access over the next three months.
“Anyone considering accessing their pension for the first time or hiking withdrawals to cope with rising living costs should stop and think before making a rash decision. Taking money out of your retirement pot early or withdrawing too much, too soon could have disastrous consequences over the long-term.
“What’s more, pensions benefit from generous tax treatment on death, meaning it often makes sense for your retirement to be the last asset you touch.”
Pensions can be accessed from age 55, with this minimum access age due to rise to 57 in 2028. However, Selby says if a healthy 55-year-old with a £100,000 pension pot were to withdraw £5,000 a year, increasing annually in line with inflation at 2%, and enjoy 4% annual investment growth after charges, their fund could run out by age 80.
“Given average life expectancy for a healthy 55-year-old is in the mid-80s, such an approach would clearly create a serious risk of draining your pot early. Withdrawing too much, too soon from your fund means you’ll increase the risk of running out of money early and potentially being left relying on the state pension.”
In 2023/24, the full flat-rate state pension will increase by 10.1%, raising its value from £185.15 per week to £203.85 per week. While this represents a valuable foundation income, it falls a long way below the spending needs of most people, says Selby.
He explained: “Put simply, if you raid your pension pot early, you’ll either need to keep your withdrawals very low, potentially harming your quality of life later in retirement; find other sources of income; or face up to the prospect of your pot running out sooner than planned and being left relying solely on the state pension.”
AJ Bell says accessing a pension early could also result in pension savers missing out on investment growth.
As an example, AJ Bell says if someone with a £100,000 pension pot withdraws £10,000 on their 55th birthday and enjoys 4% investment growth after charges, by age 65 their fund could be worth £133,000. However, if they had left the pension pot untouched, their fund would be worth £148,000 at age 65.
Selby says those considering withdrawing taxable income should also be aware that they could trigger the money purchase annual allowance and lose the ability to carry forward unused pensions allowances from up to three previous tax years.
He said: “If you are struggling to make ends meet and your pension is the only asset available to support you, consider just taking your tax-free cash as this won’t trigger the MPAA.
“Alternatively, it is also possible to access up to three personal pensions worth £10,000 or less – and unlimited occupational pensions – without triggering the MPAA, provided you exhaust the entire pot in one go.”
Selby added that pension savers should also consider the impact of withdrawals on inheritance tax. Since 2016, savers have been able to pass on leftover pensions tax-free if they die before age 75. Where the pension holder dies after age 75, the remaining funds will be taxed at their recipient’s marginal rate when they make a withdrawal.
“The removal of the lifetime allowance tax charge from 6 April 2023 makes the tax treatment of pensions on death even more attractive. For those who want to leave assets to loved ones, it therefore often makes sense to leave as much of your pension untouched as possible in order to minimise your tax bill.
“This means when you come to flexibly access your pension for the first time, you should think not just of your retirement income strategy but also your IHT plans. If you have money held in an ISA, for example, this will count towards your estate on death.”
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