Seven questions to ask before withdrawing from your pension

When you approach retirement, you will need to decide how you want to draw from your pension. In regard to personal pensions such as SIPPs (Self-Invested Personal Pensions), you can only access your pension after you turn 55, but in 2028, the age you can access your pension is increasing to 57.

At this point, your options include leaving it invested while taking an income (known as ‘drawdown’), purchasing a guaranteed income in the form of an annuity, taking lump sums, or a combination of these. Each option requires careful consideration.

So, what should you know before taking out from your pension? To help plan what is right for you, here are seven important questions you should ask yourself.

1. When do I need the money?

Some people’s instinctive reaction to getting to retirement age is to ‘grab’ what they can from their pension pot. But if you don’t have a specific purpose for the money then it may be better to keep it in a pension to remain invested tax-efficiently, in order to maximise a regular income in the future.

In particular, cashing out at an inopportune time amid market volatility can be damaging. If you don’t need money right away, then keeping invested could be better. However, you should understand how that money is invested in order that the strategy meets your objectives and likely timescales for drawing on it. Broadly speaking, the closer you are to drawing on the money the more you should have in cash and stabilising assets versus higher-risk areas such as shares.

2. How much tax will I pay?

Once you are 55, it’s possible to take all of a personal pension as a cash lump sum. While it can be tempting to do so it’s not usually a good idea. Normally, only the first 25% is tax-free, with the remainder added to your income for the tax year before being taxed. It may even take you into a higher income tax bracket. If you want to take all your money out it may be better to stagger withdrawals over a number of years.

It is also worth noting that pension pots generally fall outside your estate for inheritance tax purposes, which is why people sometimes use other assets to provide for their retirement before drawing on them.

3. How much of my pension income is guaranteed?

Thanks to increasing longevity and low-interest rates, annuity rates fell over much of the past decade. Yet they have improved significantly this year, reaching a 14-year high as interest rates and inflation expectations increased. Annuities can be an important tool for many retirees because they provide a guaranteed income for the rest of your life – no matter how long that turns out to be.

Other options give you flexibility and control but also come with substantial risks. In particular, if you rely on drawdown to fund your retirement you risk running out of money if you live longer than expected, or a market tumble hits the value of your pension pot. Having at least some of your income guaranteed either with an annuity or a protected income from another source such as a defined benefit pension scheme can help to ensure you can always meet bills and basic living expenses.

4. Do I want to manage my investments?

If you choose to go into drawdown you will need to commit to carrying on investing your pension pot – and to the work and risks that involves if you decide to take a ‘DIY’ approach. You will need to select and manage the investments or arrange to have them managed for you. Initially, you will have to work out how much money you can realistically afford to take out without putting your financial security at risk, and then regularly review your investments as disappointing returns could affect the sustainability of your income.

5. Will my spouse or partner have enough money if I die?

The more money you take out of your pension pot the less there will be to provide an income for your spouse or partner should you die first. You, therefore, need to estimate what income your spouse or partner could generate from their own sources and the possible death benefits from the options you are considering.

Buying an annuity involves giving up control of the capital value of your pot and income will stop on death unless specific options to protect the income or purchase price have been selected at the start. The main options are a dependant’s pension, whereby annuity payments will continue to be paid at the level you choose to a surviving spouse or civil partner until they die, and a guarantee period, which means that even if you die early into retirement, the annuity will continue to pay out for a minimum period of time.

If you keep your pension invested when you die the value of your pension fund would be payable either in the form of a cash lump sum or as an income to the beneficiaries you choose. If you pass away before you reach age 75, and as long as the fund is less than your remaining lifetime allowance (up to a maximum of £1,073,100 in the 2022/23 tax year), any payments will be income tax-free. If you should pass away on or after your 75th birthday, the benefits can still be paid as a cash lump sum or as an income, but whoever receives them will have to pay income tax on what they receive.

6. How can I ensure I am not being scammed?

Pension pots often represent large sums of money and can be a target for scammers and operators of high-risk unauthorised investments. Be very wary and only use a reputable, authorised business.

Use the FCA Register to confirm the business you are dealing with is authorised and check the FCA Warning List, a list of firms and individuals that the FCA knows are operating without its authorisation, for firms to avoid. If you deal with an unauthorised company, you will have no protection from the Financial Ombudsman Service or Financial Services Compensation Scheme if something goes wrong.

Be particularly wary of companies offering to ‘release’ your pension early – before 55. Businesses purporting to offer this are unlikely to be unauthorised or acting in your best interests. There are only a few exceptions where it is possible to take money from a pension before 55 such as extremely ill health or terminal illness. Outside these, the HMRC view withdrawals as unauthorised and imposes a 55% tax charge.

7. Should I seek pension advice or guidance?

Many pension options are irreversible so it’s important you choose wisely. If you are at all unsure, we recommend you seek guidance or take regulated financial advice. Having an expert review your situation can give you confidence that the decisions made are right for you. Our OneStep Financial Plan could help you understand your specific situation and plan your retirement, while Pension Wise, the Government’s free service offers guidance to those over 50s on pension matters.

What sort of retirement can you afford?

Visit our Options at Retirement Hub, to learn more, or to arrange a free initial consultation with a dedicated planner to discuss how you can make the most of your retirement savings.