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The arrival of the new tax year typically sparks a rush in pension withdrawals as retirees seek to take advantage of fresh tax allowances, according to figures from HMRC. Last year, though, set a record: £3.6 billion of taxable payments were withdrawn by around 500,000 people over the second quarter of the year – a 23% increase in comparison to 2021.
The spike has left some pension experts concerned. It appears hefty cost increases amid an eye-watering cost of living crisis have forced retirees to turn to their pensions to make ends meet. But for those hiking withdrawals to cope with rising costs, or indeed those turning to their pensions for the very first time, it’s worth remembering that the consequences of these decisions on their retirement could be significant.
Here’s four things to consider before raiding your pot:
1. It could run out prematurely
The rules state that you can start drawing on your pension at 55, rising to 57 in 2028. At this point, you’ll face a conundrum: not knowing when you will die and therefore how long the pot needs to last.
Let’s say you’re a 55 year-old with a fund of £100,000. According to numbers crunched by stockbroker AJ Bell, if you withdraw £5,000 per year, and increase withdrawals each year by the Bank of England’s long-term inflation target of 2%, and add in 4% of investment growth after fees, by the time you are 80 the pot will have all-but run out.
This could leave you with having to rely on the state pension. Even after double-digit increases this year, at £10,600 for 23/24, it likely falls way below what many people need to cover their living expenses.
2. The Money Purchase Annual Allowance (MPAA) may be triggered
At the age of access, you are allowed to withdraw 25% of your pension tax free, but if you take even just £1 of the 75% that is taxable, it will trigger the MPAA. As a result, contributions that attract tax relief – income tax that you are refunded – reduce from £60,000 per year down to £10,000, and you can no longer carry forward up to three years of unused allowances.
Given the changing nature of careers and the fact that many employees in their 50s drift in and out of work, it may severely impact the amount you can save tax efficiently.
3. Withdrawals may reduce benefits
It’s worth noting that drawing on any part of your pension may affect entitlements to means-tested state benefits such as housing and income support.
What’s more, generous death benefits on pensions mean there may be implications regarding inheritance tax (IHT) – tax applied to applicable assets of an estate of someone who has died. As tax rules currently stand, pensions do not form part of your taxable estate, whereas assets such as houses and ISAs do, so leaving your pension as unscathed as possible may be prudent if you want to minimise the IHT tax bill for your loved ones. Of course, this tax year has ushered in a raft of tax changes on investing activity, so it’s worth remembering that the Treasury and HMRC may change the rules on pensions in the future.
4. You could lose out on vital growth and income
Medical advances and increased living standards mean, broadly, we are living longer and longer. For men, life expectancy is 79, for women it’s 82. Given the number of years your pot may need to last, it’s worth remembering that withdrawals today will have an outsized impact on the size of your fund down the line given the powerful effect of compounding on your returns – the impact of gains building upon gains.
AJ Bell have run some numbers. If you have a £100,000 pot and withdraw £10,000 on your 55th birthday, and the remainder then carries on growing at 4% after fees, at 65 your fund would be worth £133,000. If you didn’t withdraw the £10k at 55, at 65 the fund would be worth £148,000 – a sizeable £15,000 more.
Alliance Trust for your retirement
With more than £3 billion in assets, Alliance Trust is designed as a core holding for your retirement pot, seeking to provide both growing capital and rising income. As such, it aims to provide real, long-term returns, and has increased its dividend every year for 55 consecutive years.
This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of Towers Watson Investment Management (TWIM), the authorised Alternative Investment Fund Manager of Alliance Trust PLC, and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at May 2023 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
TWIM is authorised and regulated by the Financial Conduct Authority. Alliance Trust PLC is listed on the London Stock Exchange and is registered in Scotland No SC1731. Registered office: River Court, 5 West Victoria Dock Road, Dundee DD1 3JT. Alliance Trust PLC is not authorised and regulated by the Financial Conduct Authority and gives no financial or investment advice.
 Source: AJ Bell, as at 05/04/2023
 Source: AJ Bell; as at 05/04/2023
 As at 30th April 2023