3 important considerations if you're using drawdown to access your pension in 2023
The introduction of Pension Freedoms in 2015 gave you more flexibility in accessing your pension than ever before.
Now, after the age of 55 (rising to 57 in April 2028), you can choose to move your pension fund into drawdown so that you can take income from it as and when it suits you.
While drawdown certainly has benefits, it’s not suitable for everyone. There are some important considerations that could affect if and how you use it to take your retirement income, particularly in light of the cost of living crisis. Read on to learn more about the benefits and potential disadvantages of accessing your pension using drawdown in 2023.
Drawdown allows you to withdraw a flexible income from your pension
In the 2023/24 tax year, you can typically access up to 25% of your pension pot tax-free when you first access it. This is known as the “pension commencement lump sum” (PCLS), and you can withdraw it as a lump sum or, if your provider allows it, apply it to a series of smaller withdrawals.
If you take your PCLS as a lump sum, any future withdrawals may be liable for Income Tax at your marginal rate. If you choose to take a series of smaller withdrawals, 25% of each withdrawal would be tax-free and the remaining 75% of the withdrawal may be liable for Income Tax.
It’s important to note that, in 2023/24, there is a cap on the PCLS of £268,275, which is 25% of the Lifetime Allowance (LTA). If you have a higher protected LTA, though, you may be able to take up to 25% of the higher amount tax-free.
If you choose to use drawdown for your withdrawals, then the remainder of your pension will typically stay invested and have the opportunity to grow further – though positive returns aren’t guaranteed.
It is your choice how often you withdraw from the pot, and how much you choose to take out each time, when using this method. Remember that larger withdrawals could place you in a higher tax band for the year, meaning you could pay a higher rate of Income Tax.
There are 2 key benefits to using drawdown to access your pension
Drawdown is a popular way to access your pension because of two key benefits it offers.
1. A flexible retirement income to suit your changing needs
Unlike an annuity – an insurance product you can buy that pays a fixed or inflation-linked income – drawdown offers you complete flexibility over how often and how much you choose to withdraw from your pension.
This can be helpful if you’re unsure exactly how much income you are likely to need each year, or if your needs might change from year to year.
For example, you might be planning on travelling to new holiday spots in the first few years of your retirement. So, you might need a higher income than in the subsequent years when you plan to stay at home more.
2. Your pension remains invested, potentially benefiting from more growth
By only taking out what you need now and keeping the rest of your pot invested, you leave your remaining savings invested in the market. This offers the potential for positive returns.
This can be especially beneficial if you have some big financial goals for your retirement. Remember that investment returns aren’t guaranteed, but a balanced portfolio can help you to manage that risk.
The cost of living crisis may influence how you access your pension
While the benefits of drawdown may be attractive, the cost of living crisis means there are some important considerations to bear in mind before deciding how to access your pension in 2023.
1. You’ll need to manage your withdrawals carefully
As the saying goes: with great power comes great responsibility. While flexibility can be beneficial, you’ll need to manage your withdrawals carefully to avoid running out of money in later life.
This is especially true when inflation is high, which has been the case during 2022 and 2023. As prices rise throughout your retirement, you may find that your usual income doesn’t stretch as far.
While it might seem logical to withdraw larger amounts to cover your day-to-day costs, this could increase your risk of running out of money later in life. A helpful way to avoid this could be to take additional income from alternative sources, such as your cash savings. This could help you to cover cost increases in the short term without depleting your pension pot too quickly.
2. Holding too much of your pension withdrawals in cash could be risky
As you read above, the PCLS allows you to withdraw up to 25% of your pension pot tax-free when you first access it.
While this can be a great way to fund your early retirement, it could mean holding a significant amount of your retirement savings in cash after you have withdrawn them.
This can be risky during times of high inflation because the interest rates on cash savings accounts are still lagging behind the rate of inflation. Inflation in the UK was 6.7% in the 12 months to August 2023, while the highest easy access savings account interest rate as of 21 September according to Moneyfacts was 5.1%.
Consequently, if you hold large sums in cash for a long period of time, the buying power of your money could begin to drop. This could make it harder to achieve your financial goals. Meanwhile, leaving your funds invested could expose them to the potential of inflation-beating returns.
3. It may be sensible to leave your pension invested during market volatility
A further consideration given the current economic landscape is whether it may be beneficial to leave your entire pension invested in the short term.
As inflation has soared in recent years, the uncertainty has led to some volatility on the stock market. Consequently, your pension may have missed out on the level of growth you might have expected in that time.
If this is the case, it might be more beneficial to leave your pension invested. This could provide an opportunity for it to generate positive returns and recover any losses you may have experienced.
To do so, you could use alternative savings for income in the short term, such as from other savings accounts or ISAs. Or, if you prefer, you could delay your retirement. This has two benefits:
· Your pension remains invested for longer, potentially benefiting from positive returns.
· You may be able to make further pension contributions, which could enable you to grow your pot further.
Get in touch
Drawdown can be a helpful way to access your pension, but it’s not right for everyone. If you’d like to learn more about whether it’s suitable for you and how to get started, we can help.
Email info@informedpensions.com
Call 0880 788 0887
Please note:
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
The Financial Conduct Authority does not regulate tax planning.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.