Since the new pension freedoms came into effect last April, people planning their retirement have had greater choice in how they access their pension pots once they reach the age of 55. Some have chosen to put in place plans to withdraw their pension savings over a period of anything from two to 10 years, in regular or ad-hoc withdrawals.
What to think about before deciding on this option
- This option is taxed differently, with 25% of each payment being tax-free. It may be more tax efficient to take a tax-free lump sum first if you expect your tax rate to be lower in the future.
- While spending in early retirement is usually higher, remember you may need to spend more in your late 70s and 80s on items like home maintenance, or potentially some care costs.
- If you’re taking your pension pot over a short period of less than five years, you may decide to invest in a less risky investment strategy than you have previously taken. This will help avoid the risk of the value of your investment falling when there is insufficient time for it to recover in value.
- If drawing income or making withdrawals from your capital over longer periods, think about whether your current investment approach remains suited to your needs.
Ad-hoc withdrawals and tax
A new option introduced in April 2015 is taking your pension pot in ‘ad-hoc’ amounts – this means taking money as and when you need it, rather than in regularly-spaced instalments. 25% of each withdrawal is tax-free, with the other 75% taxed at your highest marginal rate of income tax.
If you expect to pay a lower rate of income tax in the future, then taking the tax-free lump sum first may be a better option as this will reduce the amount of tax you pay on the taxable part, assuming you take that when your top tax rate is lower.
Taking your pension in a series of ad-hoc withdrawals is a good way to supplement other sources of income such as the state pension or an employer’s pension, and if you have reduced your work and earnings in the run-up to retirement.
Remember to plan for the long term
Although there is a temptation to spend more in the early years of retirement, particularly if you are still active, remember that the later years can also be financially draining – especially if you have to pay for some or all of the costs of long-term care, or major alterations to your home. So think about keeping at least some of your pension pot aside to cover unexpected events.
If you plan to take ad-hoc withdrawals, over the coming years, it's important that you consider whether or not you're in the right investment for your needs.
When considering what investment is right for you, you should consider how long you intend to leave the money invested, your attitude to investment risk and your ability to absorb any loss should this occur. You may well decide to take different investment strategies for any short and medium to longer term goals.
What else might you do?
For other ways of accessing your pension, see: