Dipping into your pension savings early to cover soaring living costs might seem a tempting option but should only ever be a last resort.
According to Scottish Widows latest Retirement Report, more than one in 10 (11%) people in their 50s said that they were worried about having to take money out of their retirement savings early to support their short -term financial resilience.
Soaring living costs mean many people are struggling to make ends meet, and with more pain on the horizon when energy costs increase from October, it’s not hard to understand why taking money out of your retirement savings might seem worth considering.
Pension freedom rules introduced back in 2015 made it possible for savers aged 55 or over to access their defined contribution pension savings flexibly. Since then, millions of people have taken money out of their pensions, with latest government figures showing that Between April and December 2021, £8.3 billion was withdrawn flexibly from pensions. This represents a 19% increase compared to the same period of 2020 when £7 billion was withdrawn.
Pete Glancy, head of policy at Scottish Widows, said: “We are facing a myriad of issues and there are no easy solutions. It’s sadly understandable that households are being forced to make some tough choices in their budgets, but it’s important they do so whilst taking a longer-term look at their finances.”
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Although dipping into your pension could help alleviate some of your current financial difficulties, bear in mind that it will mean you have less to live on in years to come.
Sarah Pennells, consumer finance specialist at Royal London, said: “Our cost of living research showed that 12% of people were thinking of dipping into their long term savings such as a pension to cover the increased cost of living. We’d recommend that anyone worried about debts talks to a free to use debt advice charity such as StepChange or National Debtline, as there may be other ways of dealing with debts that don’t involve breaking into your pension and potentially running out of money later in life.”
Remember too that if you take out a large lump sum or cash in your entire pension, you may be pushed into a higher tax bracket. For example, if you’re a basic-rate taxpayer, you could end up paying tax at the higher rate as a result of the withdrawal from your pension.
It’s also worth bearing in mind that if you do dip into your pension savings, this will reduce the amount you can pay into your pension each year, known as your annual allowance, from £40,000 to just £4,000, at which point it becomes known as the money purchase annual allowance (MPAA).
Ian Browne, pensions expert at Quilter, said. “There are ways to mitigate the MPAA before it is triggered such as withdrawing from small pots, where you can withdraw up to £10,000 on three occasions without activating the MPAA. You can also take your 25% tax free lump sum so long as the rest is placed is put into a flexi-access drawdown scheme with no income withdrawn. It can be a complicated area so speaking to a financial adviser could be beneficial for you.”
If you’re already retired and using drawdown to take an income from your pension, think carefully before taking out larger sums to cover living costs. Becky O’Connor, head of pensions and savings at interactive investor said: “If you are drawing an income from your pension and are considering withdrawing more than usual to cope with rising living costs, check whether your new withdrawal rate is sustainable and if not, consider reverting back to a lower amount if and when costs ease up a bit.
“You don’t need to keep withdrawing the same amount from your pension every year and many people need less as they get older – worth bearing in mind if you have a strategy.”