5 Things To Consider Before Taking Money From Your Pension

It can be tempting in your early retirement years to take money from your pension pot – especially if you find yourself short of cash. But before you do, there are a few things you should consider. In this blog, Hilltop discusses five potential consequences of withdrawing money from your pension too soon and offers advice on making the most of this valuable savings vehicle. 

Can I Withdraw From My Pension?

The answer to this question depends on the type of pension you have. For example, if you have a defined benefit pension, also known as a final salary pension, potentially, you won’t be able to make withdrawals until you reach the schemes retirement age. On the other hand, if you have a defined contribution pension, you’ll usually be able to make withdrawals from the age of 55. This could either be via: 

• One or several tax-free lump sums.
• Purchasing an annuity for a guaranteed income for life.
• Taking regular lump sums or one-off withdrawals and leaving the rest invested (pension drawdown).
• Or a combination of these options.

5 Factors To Consider Before Taking Money From A Pension

If you’re thinking about withdrawing money from your pension, you should consider these five factors first:

1. Tax Implications

Unless you’re a professional footballer, a member of the armed services or terminally ill (and a handful of other limited circumstances), you can’t take money from a pension before age 55. If you withdraw money from your pension after you turn 55 (57 from 2028), you won’t have to pay income tax on the first 25% of the money you withdraw. 

Naturally, that makes an early pension withdrawal (before retiring) extremely tempting, but it comes with risks. Withdrawing money from a pension in a large lump sum rather than smaller sums spread over the tax year can push you into a higher tax bracket. The same is true if you start taking money from a pension but still have another income source, such as a rental property or part-time job. Plus, any money you take to pass to your loved ones could be subject to Inheritance Tax (IHT). Leaving it in your pension can keep it sheltered from IHT.

2. Impact On The Future

Withdrawing money from your pension at the earliest possible opportunity can significantly impact your retirement income. Your money needs to last a lifetime, but unless you purchase an annuity, your funds could run out, leaving you in a precarious situation. For example, suppose you take out a significant portion of your pension pot early in retirement. In that case, you may not have enough to cover unforeseen medical or care costs later in life. You also remove the opportunity for your funds to accrue investment returns (although this isn’t guaranteed).

3. Whether You Will Still Make Pension Contributions

If you take money out of your pension pot, you may not be able to make any significant further contributions to your pension. This is because of something called the money purchase annual allowance (MPAA). The MPAA is the maximum amount of money you can contribute to your pension each year once you start taking taxable income out of your pension pot. For the 2022/23 tax year, the MPAA is £4,000.

This means that if you take money out of your pension pot over and above the tax-free threshold and then want to make further contributions, you’ll only be able to contribute a maximum of £4,000 each year. This is a significant reduction compared to the full allowance of £40,000. This is worth bearing in mind if you intend to continue working while taking money from your pension pot.

4. Is The Timing Right?

Timing is everything when it comes to withdrawing money from a pension. If you can supplement your retirement income in other ways, it might be prudent to wait. Can you take money from your pension later down the line? This can certainly be a helpful strategy if your pension investments have suffered a loss because it allows them to recover and recoup some or all of those losses.

The opposite is also true if you have a higher-value pension pot. Any significant market gains could push you above the Lifetime Allowance, which is the total amount you can accumulate whilst still enjoying tax benefits. In such instances, you can expect to pay a tax charge for going over the allowance. In this case, you might be better off withdrawing tax-free cash from your pension to avoid breaching the limit. 

5. Can You Use Other Assets?

Before taking money from your pension pot, consider using other assets to access the money you need. As we’ve mentioned, withdrawing from a pension early can be a risky move, as it can impact your future income. Therefore, if you have other assets, such as savings or property, you may be able to use these instead. This can help to protect your pension pot and ensure you have enough money for a comfortable retirement.

If you’re tempted to cash in a pension, remember that you have options. Taking the 25% lump sum in one fell swoop may not be the best choice in the long term. So why not consider alternative avenues at your disposal? An annuity offers the greatest peace of mind, while a pension drawdown gives you the flexibility to dip in and out of your pension pot while keeping the rest invested. Don’t forget other savings vehicles as well, such as ISAs.

Pension Advice From Hilltop

If you’re considering taking money from your pension, you should consult a financial adviser to get expert advice. As tempting as it can be to withdraw from a pension early in retirement, this can seriously impact your retirement income later in life. However, there are plenty of options besides taking a 25% tax-free lump sum as soon as you reach age 55, which can protect your nest egg and give you the retirement you’ve always wanted. 

If you’d like pension advice or to arrange a consultation, please contact us at 0161 413 7051. We’re open 9am to 5pm Monday to Thursday and from 9 am to 4 pm on Fridays. Hilltop Financial Planning is authorised and regulated by the Financial Conduct Authority. Our advisers have over 100 years of combined experience, we’re ranked in the Top 100 UK Financial Advisers by FT Adviser, and we have a vast knowledge of working with people like you, helping them to make the most of their finances.