During my years as a Financial Adviser I have met many clients on the cusp of retirement. When we first meet a lot of the time they have some preconceived ideas about how they will withdraw money from their pensions.
A lot of the time they have heard snippets from radio shows, read something in the Daily Mail or had advice from their friend.
The problem is, sometimes a little knowledge can be dangerous.
I’ve gathered up some of the most common theories I’ve heard during my discovery meetings with clients and thought I would dispel a few pension myths.
#1 – “The annual pension income quoted from my pension provider is not worth much at all”
As you approach retirement your pension provider will write to you and give you an indication of what your annual pension income might be.
This figure quoted assumes you are purchasing an Annuity with them. You can search the whole of the market and potentially get a better rate of income.
You could consolidate the pension pot into other pension pots which could mean the overall figure is more than you think.
Nowadays there are a whole range of options for taking your pension and you don’t need to lock into a fixed level of income for the rest of your life.
If your pension pot size is small and it is only one part of a larger retirement portfolio then you could take the whole lot out in one go, or larger chunks out during your early years of retirement.
Be mindful of your tax position though.
#2 – “I have to take my tax free cash lump sum out in one go”
Not true. This will depend on how you withdraw money from your pension.
If you opt for something called flexi access drawdown you can withdraw bits of your tax free cash lump sum each year until it runs out.
Your lump sum is usually limited to 25% of the total pension pot.
Be aware that there are dangers of pension drawdown.
#3 – “I’m going to take my lump sum out to cover my income requirements for the first X number of years and pay no tax”
Yes this could be a possibility, but if you have no other taxable income then you could be missing out on the opportunity to use up what’s called your Personal Allowance.
Currently at the time of writing everyone is entitled to a Personal Allowance of £11,850. This means you can earn £11,850 before paying any Income Tax.
If you retire a few years before you reach your government State Pension age then this could be the time to get money out of your pension that would normally be taxable, tax free.
As an example, if you needed £15,800 income from your pension, you could withdraw £11,850 ‘taxable’ and £3,950 tax free lump sum and the whole amount would be tax free.
#4 – “I can now take my tax free lump sum out so I should withdraw it and stick it in the bank”
Again, you could do this but you will be taking it from a place where it is probably invested and growing tax free at a decent rate over the long term to a place where it will earn little interest and depending on the size of the amount, could be taxable.
#5 – “My pension is worth X so if I divide X by the number of years I estimate I’ll live, that’s how much I’ll withdraw each year”
If only life was so simple.
Most people underestimate how long they will live. You can check current life expectancy rates here.
Also, there is a silent killer that will attack your earnings in the future and it’s called inflation.
The cost of living rises over time, so what you need in income today will be more in the future.
#6 – “I should be taking less risk with my investments as I get older”
This will largely depend on how you wish to withdraw money from your pension in the future.
If you opt for an annuity then yes, it may make sense to de-risk as you approach your retirement date. However, if you are looking at flexi access drawdown then you may well be invested for the rest of your life.
Your money will need to outpace inflation and recover from nasty stock market falls throughout your retirement so you need a good average return.
At the end of the day everyone’s situation is different and what works for your friend may not work for you.
A decision on your pension is probably going to be one of the most important financial decisions you will ever make along with buying a house, so professional advice is essential.
Any good Financial Adviser will focus on you first, the lifestyle you desire and will then fit the pension decisions around this.
If you want to chat about your retirement and dispel a few myths please give us a call.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
