Ruth Emery
Managing your money in retirement comes with significant challenges, including the risk of overspending and running out of funds in old age. Cost-of-living pressures have only made this more difficult in recent years.
A study by Legal & General warns that retirees could deplete their pension pots a decade early, as they take large cash lump sums and withdraw too much in monthly income.
The insurer suggests the “lottery effect” – where overnight access to large sums of money can lead to impulsive financial decisions – could be a key factor.
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Katharine Photiou, managing director, workplace savings at L&G, comments: “For most people, their pension pot is the largest sum of money they’ll have access to, and after decades of hard work and saving, it’s natural to view it as a well-deserved reward.
"As we know, many people do sit on their savings and will have enough to last through the years they are retired. However, our research shows the sudden financial freedom can trigger ‘the lottery effect’ for some savers, which can lead to unsustainable spending.”
Savers generally expect their pension pot to last 22 years from age 60, according to L&G's analysis. But for those who may not have other sources of income, such as property wealth, or a defined benefit pension, it typically runs out by age 77, falling short of the average life expectancy of 86.
Separate research from the Fabian Society, a left-leaning think tank, reveals that nearly two million pensioners are living in poverty. This is equivalent to 16% of the retired population, up from 14% in 2010/11.
It said the state pension was too low to guarantee protection from hardship while the threshold for benefits like Pension Credit was too high. Many retirees have also lost their Winter Fuel Payment, in another blow to budgets.
Costs have been rising rapidly over the past few years, with higher energy prices hitting retirees particularly hard. Soaring housing costs have also created challenges for those still renting or paying off a mortgage in retirement.
Figures published by PensionBee last year revealed that a fifth of Britons over the age of 55 have consistently spent more in retirement than they had planned for. A further 11% said this overspending began early on in their retirement, supporting the idea of a “lottery effect”.
“It can be hard to know how much you are likely to spend,” said Becky O’Connor, director of public affairs at PensionBee. “With living and home maintenance costs often exceeding expectations, a significant chunk of today’s retirees are overspending.”
While good retirement planning, such as adopting the 4% pension rule, can help ensure you have enough to retire on, a cash management strategy is also important. We highlight four golden rules.
How to manage your tax-free pension money
You can take up to 25% of your pension pot tax-free, but before you withdraw the cash, it is a good idea to put some measures in place. This includes:
- Building emergency savings that cover one to three years of your essential spending. According to financial services firm Hargreaves Lansdown, for the average person aged 60 or over, this is between £15,403 and £46,209.
- Making a plan to avoid spending it frivolously. Remember, if you do not need the cash immediately, then there is no obligation to take the tax-free lump sum immediately or even all at once.
- Thinking about what income you may need later on in your retirement. You can either opt to buy an annuity or consider drawdown, but the more cash you take now, the lower your ongoing income will be.
- Protecting your cash from the taxman by making use of a cash ISA, which can be an easy-access or even fixed-rate ISA.
Protecting your money from inheritance tax
As well as thinking about your cash management strategy, it is important to consider how recent inheritance tax changes could impact you.
Keeping cash tucked away in your pension pot used to be a tax-efficient approach, as inherited pension pots fell outside of the inheritance tax net. However, these rules are set to change from April 2027 following changes announced in the Autumn Budget.
After this date, anyone you leave your pension to after you die may need to pay inheritance tax as well as income tax on any withdrawals. This is changing the way some retirees are behaving when it comes to cash withdrawals.
We look at your options in a separate piece on inheritance tax changes to pensions.
How much do I need to retire comfortably?
About 30% of people have no idea how much pension they will need, research shows.
According to the latest figures from the Pensions and Lifetime Savings Association (PLSA), if you are looking for the bare minimum in retirement, you will need at least £14,000 a year as a single person or £22,000 as a couple, on average. This will cover your basic needs, with a little money potentially left over for entertainment.
For a moderate lifestyle, the PLSA estimates you need £31,000 as a single person or £43,000 as a couple. This allows you to cover the essentials, leaving a little extra for foreign holidays and eating out.
For a comfortable retirement, the body suggests an average pension income of £43,000 if you’re single or £59,000 for a couple. This level will allow you to be more spontaneous with your spending, enjoying things like holidays, mini-breaks, eating out and treating the grandchildren.
Some research even suggests younger savers may need to accumulate a pension pot worth £1 million to retire comfortably, once housing costs are taken into consideration. These are not included in the PLSA figures, but have risen significantly in recent years.
One of the best ways to boost your pension pot is to increase your regular contributions, if you can. Even a small increase of 2% could add tens of thousands of pounds over the long run, once tax relief and investment growth are taken into consideration.
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