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Flexible pension withdrawals surge – 3 tips before taking an income

If you’re planning to take a flexible income, here are three essential tips to help you get the most out of your pension.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

The number of flexible pension withdrawals made in the first few months of 2021 have surged with over 383,000 payments made in January to March. That’s up 10% compared to this time last year. Although the average value taken out is down slightly, pension savers have still withdrawn over £2.6 billion between them – up 6% compared to last year.

There could be a number of reasons why more withdrawals are being made this year, and why the average value is less. But having seen an unusual 4% reduction in withdrawals among our own clients in April to June 2020 compared to 2019, the likelihood is that the reasons are partly tied to the pandemic.

We might yet see withdrawals increase in line with spending opportunities, as lockdown restrictions are lifted and the markets continue to show signs of recovery. People could be finding the confidence again to take money from their pensions and continue with their retirement plans.

If you’re thinking about taking a flexible pension payment, there are three essential tips to consider first.

This isn’t personal advice. What you do with your pension is an important decision. Check you're making the right decision for your circumstances and that you understand all your options and their risks. If you're not sure what's right for you, get free guidance from Pension Wise on your retirement options, or ask for financial advice.

1. Don’t forget to balance your income and tax

The income you take from your pension is taxable. And it’s added to any other income you receive in the tax year.

A sensible way to manage your income could be to take payments in line with tax bands. For the 2021/22 tax year, you normally start paying 20% tax on any income above £12,570. It will then be 40% on any income above £50,270, for the higher-rate tax. For the purposes of this, we’ve assumed all income is employment or pension income. You can use these tax bands to your advantage by making sure your income is below these tax thresholds.

If you’re still receiving income from employment and you plan to take an income from your pension too, remember that your pension income could push you into a higher tax band.

Standard tax bands based on a personal allowance of £12,570 in 2021/22 (if you're a Scottish Rate taxpayer, different rates and bands will apply). Tax rules change over time.

Personal allowance reduces once income exceeds £100,000 and is lost entirely once income exceeds £150,000.

Our income tax calculator could give you an idea of how much tax you’ll pay based on your pension withdrawal, and any other income you’ve received in the tax year.


What about emergency tax?

It’s likely that the first time you take a taxable income from your pension, it’ll be taxed using an emergency tax code. This could mean you pay more tax than you should. To claim this back you might need to contact HMRC directly. Or they might adjust your future tax code.


2. Make sure your withdrawals are sustainable

If you choose to take a flexible income, you’ll have the freedom to choose how much income to withdraw, and when to take it.

Although it can be tempting to withdraw whatever amount you want, without any real plan in place, you could find yourself running short later on. By taking a flexible income, you’re choosing to keep your pension invested. This means you’ll need to think about an income and investment strategy.

You could choose to just take the income that your investments produce, that way you’re less likely to run out of money. This strategy is also known as taking the natural income (or the natural yield). Remember though, this strategy doesn’t come without risks. The income that your investments produce could go down, as well as up and therefore so could the amount available to withdraw.

If you need more, you could think about selling some investments. However, this does run the risk that your pension could be worth less in the future, meaning you could run out of money, so again be careful.

Remember, the value of your investments will rise and fall, so you could get back less than you invest. You also can’t usually access the money in your pension until you’re 55 (57 from 2028).

You can find more income and investment strategies in our guide to investing in drawdown.

Alternatively, you could think about using an annuity. Choosing to exchange your pension for an annuity means you’ll receive a guaranteed regular income for as long as you live. And you won’t need to worry about the stock market. Even if you choose to take a flexible income first by moving funds into drawdown, you can still swap this for a secure income later on.

It’s important to consider the right time to buy an annuity. For most people it might make sense to wait until after they’ve finished work completely. They’ll no longer have an income stream from their earnings, and an annuity can help cover their essential bills without worry. It’s worth getting quotes regularly after you finish work to find out how much secure income you could get. Annuity rates change regularly and once set up an annuity can’t usually be changed so make sure you consider your options carefully.


3. Don’t solely rely on investments for income, have a cash pot ready

As well as an income and investment strategy, it’s essential to have an emergency fund in place. This should be an easily-accessible pot of cash, which can be used to top up your income if markets dip or you have any unexpected costs to cover.

If your investments don’t perform as well as you hoped, you might have to limit the income you take from them. But holding a cash buffer could help. You could avoid having to sell investments to fund your income when stock markets aren’t doing as well.

When you’re retired, we think you should aim for one to three years of expenses in an emergency fund. It might seem a lot, but it’s important to have peace of mind with a decent cash buffer.

As we’ve seen with the pandemic, anything can happen. If the majority of your income is from guaranteed sources, like the State Pension and/or a final salary pension scheme, you might feel comfortable just having one year’s worth of expenses squirrelled away. But if most of your income is coming from drawdown, for example, three years might be better.

How much cash should I hold?

Is UFPLS better than drawdown?

There are two main ways to flexibly access your pension – but which is better? Our guide compares the two options and the benefits and risks of each one.


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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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