Olivia West, Senior Director – Private Clients at 7IM, explains how to make the most of the pension freedoms announced a decade ago – while not falling afoul of common retirement planning pitfalls.
The path to financial freedom is a marathon, and the finish line is all the rewards for the hard work you’ve put into making it to that stage.
The journey can sometimes feel long, and that’s the catch. It takes a bit of planning – or at least delegating to those who can plan for you – to reach the finish line on your terms.
Pension freedoms
It’s been a decade since then-Chancellor George Osborne announced a new piece of legislation that would become a game-changer for individuals who hadn’t yet entered retirement.
With the introduction of pension freedoms, which came into force in April 2015, it became possible for over-55s to draw down up to 25% of their pension as a lump sum, free of tax. The minimum age at which individuals can start withdrawing from their pensions is set to change to 57 in 2028.
Although the new regulation gathered many supporters, it also attracted opponents. One thing is certain regardless: pension freedoms introduced much more flexibility in the way people can manage their pensions and plan their journey towards financial freedom.
The long run
Being allowed to start withdrawing money tax-free from a pension pot from the age of 55 changes the retirement playing field for those still in employment.
This means the possibility of a higher income available earlier in life, so planning for retirement could take a new dimension.
If you’re still in employment, it’s almost certain you’ve thought about retirement. But when would you be happiest retiring? Would you have enough money to sustain the type of life you’d like to have in retirement?
Being allowed to start withdrawing money tax-free from a pension pot from the age of 55 changes the retirement playing field for those still in employment
There are many factors to consider when putting these options on the table, and it’s as normal as it is easy to feel like you might not be ready to take that step. But often, hesitation comes from doubts around whether you will be able to sustain your lifestyle when you stop working.
Leveraging professional cashflow modelling, or creating a lifetime wealth model for your own position and future, makes a huge difference here. By taking every element of your financial position into consideration, this creates a picture of what your future might look like based on a range of inputs and assumptions, which can be adjusted to reflect different scenarios or take into account different possibilities in your future (for example, spending more or less, going on more holidays, paying for a future wedding or school fees, taking into account higher future inflation or lower growth, to name just a few).
A lifetime wealth model can help answer difficult questions, such as whether you would be able to retire comfortably at a certain age, and it is based on assumptions, such as growth, interest rates, or inflation rates. Such assumptions can also be tailored to the level of risk an individual is willing to take. It’s therefore worth noting that the projected income or expected returns based on a cashflow model are not guaranteed.
A lifetime wealth model can help answer difficult questions, such as whether you would be able to retire comfortably at a certain age, and it is based on assumptions, such as growth, interest rates, or inflation rates
Top Tip
Lee Goggin
Co-Founder
More flexibility, more pitfalls
If you lead a busy job and/or earlier retirement has always been on the cards, it’s always useful to understand what life might look like after you stop working.
Feeling financially secure is extremely important, whatever your circumstances. The easiest way to be in control is to make sure your money is working for you in the most tax-efficient way.
It’s also important to understand your various sources of income in retirement, how much they could help you to maintain the lifestyle that matches your dreams, and how the remaining source of income could be invested for growth before being withdrawn.
It’s also important to understand your various sources of income in retirement, how much they could help you to maintain the lifestyle that matches your dreams, and how the remaining source of income could be invested for growth before being withdrawn
Making the decision to start drawing your income could become increasingly complex as circumstances evolve and as individuals approach retirement.
Finding the right balance between the amount to keep invested in your pension and the amount to draw down is the secret, but the answer could be less straightforward. For instance, unlike an annuity, the income you get from a pension varies depending on your fund’s investment performance. Or simply if you would like less exposure to investment risk, it is worth thinking about the value of a pension in your retirement portfolio.
But similarly, there are circumstances under which individuals could benefit from drawing down from a pension pot; for instance, it could be a beneficial option to those with different income needs throughout the year, or to those who would like to have a higher level of control of how their portfolio is invested.
At the same time, drawing down different amounts at different times could also help individuals minimise their tax liability – but again, this would largely depend on individual circumstances.
At the same time, drawing down different amounts at different times could also help individuals minimise their tax liability – but again, this would largely depend on individual circumstances.
Data published from the HMRC indicated that total taxable payments withdrawn flexibly since pension freedoms came into force in 2015 has exceeded £72.2bn as of the end of tax year 2022-23. In the tax year 2022-23, taxable payments from pensions totalled £12.9bn, compared with £11.2bn in tax year 2021-22. Whatever the course of action you take, it’s always important to make sure you’re weighing the tax-related implications of drawing down from your pension pot.
Important information
The investment strategy and financial planning explanations of this piece are for informational purposes only, may represent only one view, and are not intended in any way as financial or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
We always advise consultation with a professional before making any investment and financial planning decisions.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.
