Since 2015 you’ve been able to spend your pension as you please when you turn 55. In fact, latest figures from HRMC show that around 1.4 million people have withdrawn £21.7 million from the Defined Contribution schemes.
A Department of Work and Pensions (DWP) survey also found that some retirees are using their pension to fund luxuries as they begin retirement. But, how sustainable is that? Without a robust financial plan in place, they may find they are caught short in later life.
It’s inevitably tempting, suddenly having full access to a career’s worth of savings. You might want to treat yourself to a big purchase or travel to celebrate the beginning of retirement. You might invest in a new hobby that you didn’t have time to indulge in whilst working. In either circumstance, it’s perfectly normal to want to spend a little more when you retire. The thing is, you must balance that desire with the need to maintain a sustainable lifetime income. The DWP survey found that;
- More than one in three people who approached retirement without any financial guidance spent their pension on nonessential purchases, like a new car or holiday
- Only one in seven that sought financial guidance from Pension Wise made the same decision
From these statistics alone, the value of guidance or financial advice is clear in helping people make sustainable long-term spending decisions. The statistics also show that most people that sought guidance went on to seek further advice from a financial professional such as an accountant or financial adviser.
Your pension provision and retirement aspirations may mean you can afford luxury spending for a period of time, it’s entirely down to your personal circumstances. What is important is identifying your objectives and utilising the flexibility Pension Freedoms provide in a sustainable way.
Taking an income
The reality is that retirement is now more complex, with a variety of income options available to you, such as;
1. Purchasing an Annuity. The default choice before Pension Freedoms were introduced, Annuities are still available and provide a guaranteed, potentially inflation-linked, income for life. An Annuity is a one-time decision and is very limited in its flexibility, but may still be appropriate if you are especially risk-averse and like the security of defined lifetime income.
2. Use Flexi-Access Drawdown. It’s typical to withdraw your tax-free cash under Flexi-Access Drawdown and re-invest the remainder with a view to taking regular, occasionally variable income from it. This may be ideal if you anticipate your lifestyle changing throughout retirement, but you would be responsible for ensuring the level of income remains sustainable. You or your appointed financial adviser would also need to manage the risk and volatility of underlying investments.
3. Withdrawing lump sums. You can withdraw your entire pension in one go if you want. Typically, the first 25% is tax-free and you will need to pay income tax on the remainder. Obviously, if your pension is quite large, this would cause an unnecessary tax bill, so it may be advisable to make several lump sum withdrawals over time.
4. Mixing your options. There is no reason not to use a combination of the above. You could mix and match the options to create a retirement income that suits your attitude to risk, aspirations and priorities.
Is luxury spending sustainable for you?
There are four primary influences to assess your financial security in retirement, and your ability to enjoy yourself without running out of income. As financial advisers, we can help you identify and realistically plan for them, but in brief, you should consider;
1. Your pension savings and available assets. To calculate your likely income, first, you need to know exactly how much you’ve saved towards your retirement. It might not just be the value of your pension; more people are turning to alternative assets such as ISAs and property to supplement their pension income.
2. Your health and longevity. Knowing how much you have saved is largely irrelevant if you don’t consider how long it will need to provide an income for. The vast majority of people underestimate their lifespan, so be realistic with your likely health in mind. It’s also worth thinking about care costs towards the end of retirement, which may be a large unwanted expense at a time when your income providing assets are dwindling.
3. Your household spending. Calculating your essential spending for everyday life will create a base level of income required. It should cover areas such as food, utility bills and clothing. Look at your current spending habits to build a realistic picture of what you may spend. This helps you to create a minimum income your pension needs to generate annually.
4. Your aspirational spending. Now you appreciate what you’ve saved, the length of time it’s likely to provide for, and a base cost for your anticipated day-to-day living, the remainder can be allocated over your twenty, thirty or forty-year Spending it all immediately on a luxury yacht may be a little risky, but planning a conscious spend throughout retirement may mean your income remains sustainable, whilst fulfilling your aspirations.
These four points are designed to give you some food for thought; there will be other factors reliant on your personal circumstances. If you’d like to build a sustainable retirement income plan, no matter what your age, we have more than 25 years’ experience in doing so.
By retaining pension benefits within a Flexi-Access Drawdown arrangement, please be aware that the fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
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