This content is for information and educational purposes only. It should not be taken as financial advice or investment advice. To receive tailored, regulated financial advice regarding your affairs please consult us here at Hanson Financial Services (financial advice and planning in Liverpool).
In 2020-21 there are two main ways to use a pension pot. Firstly, you could buy an annuity to provide you with a lifetime income in retirement. Secondly, you could take the money out slowly throughout retirement to live on. This latter method is called drawdown – or “income drawdown” and it’s an option for over-55s with a defined contribution pension (set to rise to 57 in the future).
How does drawdown work, exactly, and how can you draw down a pension wisely – without the fear of running out of money in retirement? In this post, our financial planning team at Hanson Financial Services in Liverpool offers some insights and information to help your thinking. Please get in touch if you’d like to discuss your own questions and situations with us (contact information below).
How drawdown works
The idea of drawdown is relatively simple. Once you retire, you take your pension and take some money out for an income – whilst keeping the rest invested, so it continues to grow over time. In 2020-21, you can take up to 25% out of your pension pot(s) if you want to, although you should consult a financial adviser before doing so. Whilst it may be attractive to suddenly gain access to tens/hundreds of thousands of pounds, taking lots out at once can disproportionately reduce your retirement income later.
Under current pension rules, new income drawdown arrangements established after 6th April 2015 (the “pension freedoms” date) are subject to “flexi-access drawdown” rules. This lets you take up to 25%, tax-free, up-front. It also gives you the ability to take the rest of your savings out all at once, or in stages – subject to tax.
If you took out pension drawdown before the pension freedoms, however, then you will likely be subject to either: capped drawdown rules or flexible drawdown rules. With the former, you are limited to how much income you can withdraw (i.e. up 150% of your annuity income, had you bought one). With the latter, there is no limit provided you have retirement income worth at least £12,000 from other sources.
How do I draw down without running out of money?
Here at our financial planning office in Liverpool, part of our answer to this involves asking two more questions: “How much do you need in retirement”, and “Are you on track to achieve this?” Determining these two answers will help you avoid drawing down too much, too quickly – i.e. your “safe withdrawal rate”.
The amount each person (or couple) needs in retirement depends on your financial goals and situation. Here, you should try to work out your essential, fixed expenses in retirement and the “luxury” (nice-to-have) ones – such as annual holidays. Add all of these up to get a monthly idea of your costs. You’ll need to factor inflation and your state pension into your calculations too. Here, a financial adviser can bring much greater focus to your working. From there, multiply your monthly figure by 12 to get your annual income.
To illustrate, let’s take an example. Suppose you will receive the full new state pension when you retire in 10 years (i.e. £9,110 pa). You also estimate that your monthly outgoings – for a comfortable retirement lifestyle – will be about £2,500, which is £30,000 per year. This means that you need to generate at least £20,890 from other sources apart from your state pension, such as your defined contribution pension pot(s) – which you might hope to draw down from.
If this is what you might need each year, you can start to forecast what kind of pension pot you may eventually need over ten, twenty or thirty years. Here, again you’ll need to factor inflation in – as well as taxes, fees and likely investment growth. Then, with your “target figure” more clearly in mind, you can start to figure out the question: “Am I on track to achieve this amount with my current pension savings rate?”
If not, then perhaps you need to consider increasing your contributions. Alternatively, you might need to revise your expectations about how much you can safely draw down in retirement for your pension(s) to remain sustainable. It would be easy to run out of money more quickly than you expected. For instance, suppose you take 10% out of a £200,000 pension each year when you retire to provide a £20,000 annual income. Assuming 5% investment growth after costs, a “moderate” investment strategy and a 2% annual increase (to meet inflation) this reduces your pot by 5% each year. With such a strategy, you might expect your pension to last 12 years before it runs out completely. To avoid this, your financial adviser might recommend a range of options including adjusting your investment strategy and/or your withdrawal rate.
Are you interested in talking to an experienced financial adviser about your pension planning needs? We’d love to assist you here at Hanson Financial Services.
Please contact us to arrange a consultation with our team – free and without obligation – to gain more clarity and peace of mind over your financial plan.
You can call us on:
Liverpool Office: 0151 708 7616
Manchester Office: 0161 401 0991
Chester Office: 01244 960 039Or email via: [email protected]