It’s probably fair to say that Kwasi Kwarteng’s “mini-Budget” turned out to be quite a big deal. After revealing a series of tax cuts, the former chancellor’s economic strategy resulted in the pound plummeting to record lows against the dollar and a downturn in the FTSE 100.
Soon after, the Bank of England announced a £65 billion bailout to protect pension funds. According to the Guardian, pension funds “almost collapsed” amid the market meltdown sparked by the mini-Budget.
Headlines like these no doubt alarmed many retirees, some of who may be clients. What they may not realise though, is that there are other ways to put their pension fund at risk.
Discover three common ways retirees jeopardise their pension fund without realising it, and why speaking to a financial planner at retirement could help sidestep them.
1. Your client could take too much money from their pension
In 2015, the Pension Freedoms legislation came into force, which allows retirees more flexibility about how they access their pension. This means they can typically access their pension in four ways, which are:
- To take some or all of your pension pot as a cash lump sum
- To buy an annuity
- To take an income from the pension fund and leave the rest invested
- To take a mix of these options.
With greater choice, however, comes greater risk, and without advice your client could deplete their pension fund too quickly. According to Unbiased, a study by Age UK reveals growing anxiety among pension providers that some retirees may be drawing too much money from their retirement fund.
One reason for this is the spiralling cost of living and energy prices, which has resulted in many pensioners having to withdraw more from their pension pots just to maintain their lifestyle. Unbiased reveals that an estimated 90,000 retirees are taking an annual income of more than 8% of their fund value.
Withdrawing an income of this size could mean a pension pot is exhausted much more quickly than expected. For example, at this level of income a pension pot enjoying a steady 6% rate of growth would be exhausted within 22 years.
At a more realistic 4% rate of growth, it would run dry in 17 years. So as you can see, accessing too much could put your client at significant risk of depleting their retirement fund, which could mean a significant reduction in their lifestyle.
That said, when the stock market is volatile, as it has been in 2022, this risk increases further, something we will consider next.
2. Your clients may access their pension at the wrong time
Unbiased reports that since the Pension Freedoms legislation was introduced in 2015, around 615,000 people have accessed their pension using drawdown. Since then the stock market has experienced downturns, such as in March 2020 when the world grappled with the Covid pandemic.
If your client accesses their pension pot when the stock market has suffered a downturn, they can suffer “sequence risk”. This is when a drop in equity prices means more have to be sold to provide the level of income required, which means the pension then holds fewer stocks and shares.
As a result, its growth potential could be greatly reduced when the market then bounces back. This means the pension fund may not be able to recover from the withdrawal, meaning the pension is more likely to run dry.
If your client is considering accessing their pension when the stock market has suffered a downturn, they should speak to a financial planner to explore other options. This might include living off other savings, assets or investments until the stock market recovers.
3. Your clients could pay more tax than they need to
If your client has a defined contribution (DB) pension they can typically access it at the age of 55 (rising to 57 from 2028). When they do, they can normally take up to 25% of the pension as a tax-free lump sum, with the remaining 75% subject to Income Tax at their marginal rate.
Your client’s Income Tax is calculated by HM Revenue & Customs (HMRC) by adding the income taken from the taxable element of the pension to any other earnings that they have. If they don’t manage their withdrawals carefully, they may end up being pushed into the higher- or additional-rate of Income Tax bracket, which is typically charged at 40% or 45% respectively.
According to FTAdviser, HMRC returned more than £42m to retirees who had overpaid on tax when they accessed their pensions during Q1 of 2021 alone. A financial planner could use cashflow modelling software to help your client understand how much they need to withdraw to sustain the lifestyle they want.
This could result in them taking less income from their retirement fund, which may result in your client remaining in lower tax bands. As a result, their pension could last longer that it may otherwise have done.
Get in touch
If you or your client are approaching retirement and would like to discuss how best to access your pension pot, please contact us on firstname.lastname@example.org or call 01904 655 330. As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can be sure that your clients will receive excellent advice and a high quality service.
This blog is for general information only and does not constitute advice. 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 information is aimed at retail clients only.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.