Rapid increase in lump-sum pension withdrawals among 55-year-olds: Key factors to ponder before accelerating retirement savings
Stepping up the pension cash-out trend
The surge of individuals withdrawing massive chunks from their pensions as soon as they turn 55 hit an all-time high last year, post-pandemic, and experts foresee a faster pace in the coming months, ahead of imminent inheritance tax rule updates.
120,000 people cashed out their pensions early in 2024, marking a 10% increase from 2023, according to Freedom of Information data requested by Lubbock Fine Wealth Management from HMRC. The total worth of these lump sum withdrawals for individuals aged 55 to 56 skyrocketed to a five-year high of £2.2 billion during theyear to March 31, 2024, also up by 10%.
Grabbing the gold with caution
Straining cost of living pressures might be the driving force pushing people to tap into their pensions prematurely, Lubbock Fine cautioned, as there's a high risk of running out of money later in life. With increasing life expectancy and escalating healthcare costs, the chances of burning through pension funds too quickly increases.
Andrew Tricker, Director at Lubbock Fine Wealth Management, warned, "It's deeply concerning to see such a high number of retirees dipping into their pension pots before retiring. Many are withdrawing too much too early." He added, "Given people are living longer, the cost of retirement has never been higher – money drawn out too early needs to be replaced."
The great inheritance tax escape?
This trend of early pension withdrawals could gain momentum due to upcoming changes to inheritance tax (IHT) rules, scheduled to take effect soon. Starting from April 2027, most unused pensions and death benefits will be added to an individual’s estate value. This change makes pensions less effective in transferring wealth.
Since IHT isn't levied on gifts made greater than seven years before death, people might go for cashing out their pensions early and gifting the money to family or friends to reduce their estate's value, thus minimizing their IHT bill.
However, Lubbock Fine issued a word of warning regarding tax implications, particularly the Money Purchase Annual Allowance (MPAA). The MPAA comes into play when taxable income is drawn from a defined contribution pension, using a flexible payment option. The annual allowance for future pension contributions reduces to £10,000 when the MPAA is triggered, regardless of the higher original limit.
Three things to think about before vacating your pension nest egg
Tom Selby, Director of Public Policy at AJ Bell, advises potential pension early-birds to pause and consider these critical factors:
Vulnerability to running out of pension funds in retirement
Rushing into withdrawing too much, too quickly means you increase the risk of depleting your fund before retirement, potentially leaving you relying on the state pension.
Missing out on investment growth
As you sell some of your investments to make a withdrawal, you'll inevitably miss out on long-term investment growth. Lower risk portfolios, often adopted when withdrawing income from pension, have lower return expectations over the long-term.
Triggering a significant cut in your annual allowance
Taking even £1 of taxable income from your retirement pot can trigger the MPAA, potentially limiting the amount you can save in a pension tax-efficiently to £10,000. This significantly lower allowance also applies to employer pension contributions.
Selby added, "Anyone considering accessing their pension pot for the first time or hiking withdrawals to cope with rising living costs should think twice before making a hasty decision." With careful planning and forethought, it's possible to strike a balance between minimizing inheritance tax and ensuring financial security in retirement.
- To minimize the risk of running out of funds in retirement, it's essential to tread carefully when considering early pension withdrawals, as noted by Tom Selby, Director of Public Policy at AJ Bell, as the action could lead to depleting your fund before retirement, potentially leaving you reliant on the state pension.
- When it comes to personal-finance planning, it's crucial to contemplate the potential tax implications of early pension withdrawals, such as the impact on the Money Purchase Annual Allowance (MPAA), which could significantly limit the amount you can save in a pension tax-efficiently to £10,000, as warned by Lubbock Fine Wealth Management.
