Ever since Pension Freedom rules came in to force in 2015 you have had more flexibility and control over your pension including taking pension early.
The statement above doesn’t apply to the government State Pension however, quite the opposite in fact. The age at which you can take your State Pension and the number of qualifying years you need to pay National Insurance contributions have both been increased.
If you are considering taking pension early then the rules on qualifying for the State Pension are certainly worth getting on top of.
The flexibility and control is certainly a lot different when it comes to your own personal pensions or pensions offered by your employer/former employer. For example did you know that the earliest age you can actually begin making withdrawals from a pension is 55? It could even be earlier if you have a medical condition that reduces your life expectancy.
The government has already announced that the minimum pension age will increase from 55 to 57 by 2028 as the State Pension rises to age 67.
So if you’ve already reached age 55 or are about to and thinking of taking pension early, what should you be considering?
What are the consequences of taking pension early
Defined Benefit (Final Salary pensions)
- These types of pension will have a set ‘retirement age’ factored into the scheme (usually 65).
- They will usually allow you to take an income from the pension early (from age 55) however the income they offer will be significantly reduced as it needs to pay you for longer.
- If you are still working for the company it will also mean leaving the scheme and not benefiting from any further pension accrual.
- If you have a money purchase pension (not Final Salary) then you can use pension drawdown as a way of taking as much or as little out of the pension as you want.
- Not all pensions are ‘drawdown ready’ and you may have to transfer your pension to a scheme that is.
- By using pension drawdown, not only are you in control of withdrawals but also the investment management.
- Withdrawing too much and/or making bad investment decisions can mean the pension runs out of money.
- This could lead to you taking less withdrawals when the stock markets fall meaning your lifestyle may need to change during these periods.
Buying an Annuity
- Instead of using pension drawdown you can ‘sell’ your pension fund to an annuity provider who will pay you a guaranteed income for the rest of your life.
- Similar to Final Salary pensions, the problem here is that the younger you start an annuity the longer it needs to be paid for and therefore the annuity provider will offer you significantly less income per year than if you were older.
- If you are still working when planning on taking pension early then any pension income you take over and above the pension tax free lump sum will be added to your other earnings and you could be paying a higher rate of Income Tax.
How to decide whether taking pension early is a good idea
#1 – Know where you stand
It’s absolutely crucial to know where you currently stand financially. What is your total pension pot? If you have a final salary pension, what income is quoted if you are taking pension early? What’s your State Pension forecast?
Action point: Write to your pension providers and get the latest values of all your pensions. Also get a State Pension forecast online.
#2 – Health and life expectancy
Consider your current health and look at your family history. If all is well then you could be looking at living well into your 80s and even 90s. Will taking pension early mean it lasts that long?
Action point: Overestimate your life expectancy. Add an extra 10 years onto the age you think you will live to or use at least age 100.
#3 – Don’t rely on a future inheritance
If you are planning on taking pension early safe in the knowledge that a future inheritance will bail you out if things go wrong then think again. People are living longer and longer but their bodies are still wearing down and therefore will need care. Care is very expensive and could well eat up any inheritance you were expecting. Also families quite often end up fighting over inheritances and therefore you may not get as much as you thought.
Action point: Take future inheritances out of your planning equations.
#4 – Money from elsewhere
Remember if you are still working when taking pension early then you may be paying far more tax than you need to. Do you have other tax free investments and savings you could use first? Also a pension is a fantastic Inheritance Tax planning tool as people who inherit your pension do not pay Inheritance Tax.
Action point: Consider your other savings and investments, could you downsize your home? Use the pension last.
#5 – Other guaranteed income in the future
Do you have a range of different pensions including some personal and some final salary? If so then perhaps your final salary pensions will cover all your future spending. This is good as final salary pension income is guaranteed for the rest of your life and inflation protected. You also have the State Pension to add on top.
Action point: Understand your future spending requirements, it’s always better to overestimate. Write down all your bills now and then decide what will change in the future. Check to see if your guaranteed income is likely to cover it.
#6 – Cash flow projections
The key to understanding whether taking pension early is a good idea will come from a really good cash flow forecast that factors in disaster scenarios. Projecting your income and spending for the rest of your life will give you some indication as to whether you will run out of money or not.
Action point: Set up a sophisticated cash flow forecast or pay a professional to do it.
Here at RTS Financial Planning every one of our clients has a cash flow forecast and it is regularly monitored at each review meeting to ensure they know where they stand. We test cash flows rigorously with disaster and various ‘what if’ scenarios. You can’t do proper financial planning any other way. If you would like a demo then give us a call.
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.