In 2015 the government changed the pension rules - giving much greater freedom over how you access your private pension savings from age 55.
In short, there’s greater flexibility to take all, some or none of your pension savings from this age. And these new freedoms have been hugely popular. Over one million people have withdrawn more than £30bn from their pensions. The total value of flexible withdrawals from pensions since flexibility changes in 2015 1 has exceeded £45 billion.
One of the most popular options has been that of ‘taking some’ of your pension savings, in individual payments, over time.
Some people have described this option as using your pension like a bank account. Unlike a bank account, the value of your savings will rise and fall with investment markets.
And when you’re taking money from your pension, the money is typically only flowing in one direction – and that direction is out. Your pension money has been saved to fund your retirement, so it’s sensible to ask, “Is my money going to run out too soon?”
Everyone is different, with different pension savings, needs and aspirations. So, there might not be a quick way to answer this question. But below we list five factors you should consider when trying to answer this question. We also suggest further sources of help.
And the good news is that you can typically revise the amount of money you take from your pension as you go along – up or down. With some basic planning, and a little help, you can take control of your pension and greatly reduce the risk of running out of money too soon.
Here are five factors to help you consider if your pension savings are going to run out too soon:
1. Common sense
Common sense is often a good place to begin. Your private pension savings are typically intended to fund what will hopefully be many years of retirement. Without your private pension savings and no other forms of private income, your only source of income in retirement would likely be the state pension which is currently around £185.15 per week for tax year 2022/23. Few would find this enough.
So, if you find you’ve spent a big chunk of your private pension savings in your first year of access, you wouldn’t need be a rocket scientist to guess that you are probably spending too fast and risk running out of money too soon. It could be time to slam on the brakes.
2. Life expectancy
None of us know exactly how long we’ll live, but you can find out how long you can expect to live. And this information can inform your pension spending plans. If you expect to live for another 40 years your spending habits will be very different than if you expect to live for only another ten years. We often underestimate our life expectancy as we’re influenced by the experiences of generations that went before.
Underestimating your life expectancy increases the risk of spending too fast and running out of money too soon. The Office for National Statistics has a free life expectancy calculator to give you an indication of how long you can expect to live. Understandably, it comes with no guarantee!
3. Income needs
Your pension savings are intended to meet your income needs. And these needs will change over time. Some needs may reduce as you get older – if you pay off your mortgage, for example. And other needs may increase - if you seek more domestic care in later life, for example. The key is to ensure that you keep these needs, and your monthly budget, under review.
The spending assumptions that you made on day one of retirement may now be too high or too low. Either way, this could impact your probability of running out of money too soon. And you should bear in mind inflation. If prices are rising quickly, your income needs will similarly rise. Today, inflation is relatively low, but it changes all the time.
4. Investment risk
The pension savings that you have not withdrawn typically remain invested. And, as with all investments, their value can fall as well as rise. A fall in the value of your untouched pension reduces the amount that you have available to fund your spending needs. Similarly, a rise in value boosts your untouched pension pot.
As with your income needs, it would be misguided to ‘set and forget’ your investment assumptions. You should keep a close eye on your underlying investments and consider taking action if you see a significant shift in value.
“Nothing can be said to be certain, except death and taxes” said America’s Benjamin Franklin. There is some truth in what he said, and it’s very relevant to pensions. Taxation follows you throughout your life, and it can shape the actions you take with your pension. Income tax rates and income tax thresholds can have an impact on the amount of tax you pay on money you withdraw from your pension.
Today, the standard personal tax-free allowance is £12,570 2. Any income above this is subject to income tax, but this could be changed at virtually any time by the government. In considering accessing your pension savings you should also consider today’s income tax rules.
Managing your money
Your two biggest financial assets in life are likely to be your home and your pension. You’re likely to spend time maintaining your house, why not your pension? If you’re cutting your grass on a Sunday morning, you could check your pension value online on a Sunday afternoon.
And you’re not alone. There are many sources of help available. See this month’s article on financial help for information about who could help you manage your money.