The number of people making lump-sum withdrawals from their pensions as soon as they could hit a post-pandemic high last year. Experts are predicting the trend to accelerate ahead of upcoming inheritance tax rule changes.
A total of 120,000 individuals pulled a lump sum from their pensions at age 55 last year, up 10% on 2023, according to a Freedom of Information request from HMRC by Lubbock Fine Wealth Management.
The total value of those lump sum withdrawals by people aged 55 to 56 hit a five-year high of £2.2 billion in the year to 31 March 2024, also up 10% from £2 billion.
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Rising cost of living pressures are likely pushing many individuals to access their pensions early, said Lubbock Fine, raising concerns they could run out of money later in life.
Increased life expectancy and growing healthcare costs increase the chances that individuals could spend their way through their pensions too quickly.
Andrew Tricker, director at Lubbock Fine Wealth Management, said: “The large numbers of savers withdrawing from their pensions before actually retiring is very concerning. Many of them are withdrawing too much – and too early.
“People are living longer than ever so funding a retirement has never been more expensive – money withdrawn early will need replacing. Decisions made at 55 can have serious implications when you’re in your 80s.”
Should I withdraw my pension to avoid inheritance tax?
This trend for lump sum withdrawals from pensions may accelerate due to recent changes to inheritance tax (IHT) rules, which will come into effect in the near future.
From April 2027, most unused pensions and death benefits will be included in the value of an individual’s estate. This makes pensions a less effective tool for passing on wealth.
Since IHT isn’t due on gifts made seven years before death, these changes may lead to individuals withdrawing money from their pensions early and gifting it to their family or friends. This will reduce their estate’s value – and thus their IHT bill.
But Lubbock Fine warned people should be aware of the tax consequences, particularly the money purchase annual allowance (MPAA). The MPAA is triggered when taxable income is taken from a defined contribution pension using a flexible payment option.
If taxable income is taken in addition to the available 25% tax-free lump sum allowance, then the MPAA applies and the annual allowance – meaning the amount you can pay into a pension pot and still get tax-relief – is reduced to £10,000 (from £60,000 or 100% of earnings, whichever is lower). This lower allowance also applies to employer pension contributions.
Tricker said: “People dipping into their pension pots at 55 must do so with extreme care. Triggering the MPAA can drastically reduce what you can contribute to a pension moving forward – something that often catches people out later in life.”
Tom Selby, director of public policy at AJ Bell, said: “Anyone considering accessing their pension for the first time or hiking withdrawals to cope with rising living costs should stop and think before making a rash decision.
“Taking money out of your retirement pot early or withdrawing too much, too soon could have disastrous consequences over the long term.”
Three things to consider before accessing your pension pot early
Here are three reasons Selby recommended “stopping and thinking” before accessing your pension pot straight away at age 55.
Early access increases the risk of running out of money in retirement
Withdrawing too much, too soon from your fund means you’ll increase the risk of running out of money early – and potentially being left relying on the state pension.
Take a healthy 55-year-old with a £100,000 pension pot. If they withdraw £5,000 a year, increasing annually in line with inflation at 2%, and enjoy 4% annual investment growth after charges, their fund could run out by age 80, by AJ Bell’s calculations.
Given average life expectancy for a healthy 55-year-old is in the mid-80s – with a decent chance of living well into your 90s – such an approach would clearly create a serious risk of draining your pot early.
“Put simply, if you raid your pension pot early, you’ll either need to keep your withdrawals very low, potentially harming your quality of life later in retirement; find other sources of income; or face up to the prospect of your pot running out sooner than planned and being left relying solely on the state pension,” said Selby.
Early access could also see you miss out on investment growth
The sustainability problems created by taking an income early from your pension will be compounded if you miss out on investment growth at the same time.
While savers have total freedom over how to invest their retirement fund, it usually makes sense to take a bit less risk when you start drawing an income from your pot.
At the very least you will need to sell some of your investments to make a withdrawal, meaning you might have somewhere between 12 to 24 months of income held in cash. This lower risk portfolio will inevitably have lower return expectations over the long term.
What’s more, anyone taking money out of their pot early will have any investment growth applied to a smaller pot of money.
For example, take someone with a £100,000 pension pot. If they withdraw £10,000 on their 55th birthday and enjoy 4% investment growth after charges, by age 65 their fund could be worth £133,000, according to AJ Bell’s number crunching.
If they didn’t take the £10,000 out and enjoyed the same level of investment growth, by age 65 their fund could be worth £148,000 – £15,000 more.
You could trigger a big cut in your annual allowance
“Anyone considering withdrawing taxable income from their retirement pot for the first time needs to be aware of the severe impact it will have on their ability to save tax efficiently in a pension in the future,” said Selby.
Taking even £1 of taxable income from your pension flexibly will trigger the money purchase annual allowance, potentially significantly reducing the amount you can save in a pension tax efficiently to £10,000 – a lot less than the £60,000 annual allowance.
Furthermore, if you trigger the MPAA you will lose the ability to ‘carry forward’ unused pensions allowances from up to three previous tax years.
“If you are struggling to make ends meet and your pension is the only asset available to support you, consider just taking your tax-free cash (or a portion of your tax-free cash) as this won’t trigger the MPAA,” Selby said.
Alternatively, it is also possible to access up to three personal pensions worth £10,000 or less – and unlimited occupational pensions – without triggering the MPAA, provided you exhaust the entire pot in one go.
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