2 important ways your retirement lifestyle could deplete your pension

As the cost of living and inflation continue to dominate headlines in the UK, the findings of a report published in FTAdviser will hardly come as a surprise. It revealed that nearly half of financial advisers (47%) said that they were worried that their clients have been withdrawing too much income from their pension pot.

This is an increase of 19% when compared to the last time advisers were asked the question in 2018. While withdrawing more money from your retirement fund might be understandable given the soaring cost of living in 2022, doing so could jeopardise your long-term financial security.

If you’re wondering: “could my retirement lifestyle deplete my pension pot?”, read on to discover two reasons why it could and how a financial planner could help.

1. Maintaining your lifestyle might mean your pension pot runs dry

Before the Pension Freedoms legislation of 2015, people typically purchased an annuity when they reached retirement age. This is because it provided a guaranteed income for the rest of their life.

When the legislation came into force this changed, as it provided alternative ways for pensioners to access their retirement fund. While this has advantages, such as being able to take more from your retirement fund to counter the rising cost of living, it also incurs the very real risk that you might deplete your pension too quickly.

According to a report by Unbiased, research by Age UK highlighted concerns that pensioners could be drawing too much from their fund. The study estimated that 90,000 retirees were taking an annual income of 8% or more from their funds, which could jeopardise their lifestyle over the long term.

This is because withdrawals at this level would only be sustainable through periods of strong growth. If your pension were to grow at a more realistic 4%, it goes on to say, your pension pot might only last 17 years.

Taking more money to maintain your lifestyle when the stock market is volatile, as it has been in 2022, could result in your retirement fund running out even more quickly. You could be taking a larger percentage of your pension pot with each withdrawal, which then increases the chances of your pension being depleted.

This is likely to result in a significant drop in your standard of living. That’s why speaking to a financial planner is likely to be a very wise move, as they could confirm how much income you can take without jeopardising your pension.

2. You could pay too much Income Tax

When you access your pension pot, it’s important to consider the most tax-efficient way of doing it. Typically, when you do access it, you can take up to 25% of your fund as a tax-free lump sum, meaning the remaining 75% will be subject to Income Tax at your marginal rate.

The amount of Income Tax you pay is calculated by adding any withdrawal you make from your pension pot that’s over the tax-free lump sum to other taxable income. This means that if you do not manage your withdrawals carefully you could push your overall earnings into a higher Income Tax bracket.

If this happens you could face a 40% or 45% Income Tax liability. Furthermore, you could also trigger the HM Revenue & Customs (HMRC) emergency “month one” tax code, which could result in an unexpected, and substantial, tax charge.

This could happen if, for example, you decide to take an unusually high amount to kick-start your retirement. As a result, HMRC could assume that this is the amount you will take every month, which could result in a higher Income Tax charge.

If this happens you would then need to claim a rebate, meaning you could have to wait until the end of the tax year before you receive your money.

A financial planner will be able to advise you on the most tax-efficient way to withdraw money from your pension, such as taking smaller, regular withdrawals spread over many years. This means you will pay less Income Tax, which, in turn, means you will lose less of your retirement fund to HMRC.

A financial planner could also help you help the environment

Another advantage of using a financial planner when accessing your retirement fund is that they might be able to help you do your bit for the planet. Placing your existing pension pot into sustainable investments might enable you to live the lifestyle you want while also helping the environment.

If this is something you hadn’t considered, an article in PensionsAge might make for interesting reading. It reveals that one study found that switching to sustainable investments, which are today known as “Environmental, Sustainable and Ethical” (ESG) funds, could be 40 times more powerful in tackling climate change than switching to a renewable energy provider.

That said, you should never switch your pension to an ESG fund, or any other provider or type of pension, without speaking to a financial planner first. They will be able to confirm whether the pension you are considering is right for you, as well as the risks and possible costs that may be involved.

Get in touch

If you’d like help understanding how inflation is affecting your expenditure and how you could help protect your pension pot against its effects, I would be happy to discuss it with you. Simply email me at a.douglass@grosvenorconsultancy.co.uk or telephone 01793 766 123, and I’ll be happy to help. Alternatively, call my mobile on 07525 177 046.

Please note that while I offer high standards of service and ensure any solution I recommend is right for you, I’m also a busy mum, so work Mondays and Tuesdays only.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Your pension income could also be affected by the interest rates at the time you take your benefits. Levels, bases of, and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

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