‘I’m a pensions expert – 10 things you should consider before accessing your pot’ (Image: AJ Bell)
Pension freedoms are approaching their tenth anniversary, marking nearly a decade since the reforms drastically changed how people access their retirement pots. As the anniversary nears, experts urge savers to carefully consider their options when making withdrawals. Tom Selby, director of public policy at AJ Bell, said: “These reforms have been hugely popular, enabling retirees to design an income plan that fits their lifestyle and placing responsibility for ensuring that pot lasts throughout their lifetime firmly on the shoulders of individuals.”
However, Mr Selby warned that the upcoming changes to the pension regime, particularly Chancellor Rachel Reeves’s plan to review pension tax rules from April 2027, could complicate matters for those hoping to leave money to their beneficiaries. Sharing 10 considerations people should make before accessing their pots, Mr Selby added: “It is vital people take the time to consider how they do it, how much income they take and the tax implications of any decision.”
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Britons now have more choices in managing their retirement income, but there are important tax rules (Image: Getty)
Is now the right time to access your pension?
You can access your ‘defined contribution’ (DC) retirement pot from age 55, with this minimum access age set to rise to 57 by 2028. When you access your pension for the first time, you can also get up to a quarter of your pot completely tax-free.
However, Mr Selby warned: “Just because you can do something doesn’t necessarily mean you should – and there are very good reasons to hold off doing so if you can. Perhaps most importantly, the earlier you start taking an income, the longer that income will need to last – and the less opportunity your fund, including the tax-free cash entitlement, will have to enjoy long-term investment growth.
Choose the right retirement income option
One of the biggest decisions retirees face is how to structure their income. According to the pensions expert, the most popular route is drawdown, where you keep your pension invested and take a flexible income.
Mr Selby said: “This gives you flexibility over how you take an income but requires you to be comfortable taking investment risk and having responsibility for managing your withdrawals sustainably.”
Alternatively, you could buy an “annuity”, which is an insurance product that pays a guaranteed income for life. Mr Selby said: “These are generally more suitable for people who don’t want to take any investment risk and prioritise income security.”
However, he noted: “If you go down this road, it’s important to shop around for the right product because once you buy an annuity, you can’t change your mind.”
Another popular option is to take ad-hoc lump sums directly from your pension, with a quarter of each lump sum available tax-free. These are sometimes referred to in the jargon as ‘uncrystallised funds pension lump sums’ or UFPLS.
Mr Selby added: “It is also perfectly possible to combine these income options to suit your needs. For example, you could buy an annuity to pay your fixed costs and retain flexibility and the potential to enjoy long-term growth with the rest. Equally, you could aim to take a flexible income through a drawdown in the early years of retirement and then buy an annuity when you’re a bit older and likely to get a better rate.”
Plan your tax-free cash
Up to a quarter of your pension pot can be taken tax-free. For most people, the maximum tax-free cash they can take over their lifetime is £268,275, but Mr Selby urged caution.
He said: “Before taking your tax-free cash, make sure you have a plan for the money. If, for example, you take your full entitlement out and then just shove it in a bank account, the money will risk being eaten away by inflation over time.”
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The Money Purchase Annual Allowance (MPAA)
If you plan to continue contributing to your pension after accessing it, be aware of the Money Purchase Annual Allowance (MPAA). Mr Selby said: “Usually, you can contribute up to £60,000 per year into your retirement pot tax-free, but if you flexibly access your pension, for example, through drawdown or by taking an ad-hoc lump sum, your annual allowance drops to £10,000.
“So, if you are planning to keep contributing to your pension after accessing it, you should think carefully about the impact this annual allowance cut will have and consider alternative options.”
Manage large withdrawals and income tax
It’s important to consider the tax implications when taking large withdrawals. By spreading your withdrawals over multiple years, you could reduce your tax bill and maximise your income.
Providing an example, Mr Selby said if someone with no other taxable income chose to take a £20,000 taxable withdrawal in 2024/25, they would pay 0% tax on the first £12,570 and 20% tax on the remaining £7,430, leaving a total income tax bill of £1,486.
However, he noted: “If they took a £10,000 withdrawal in 2024/25 and a subsequent £10,000 withdrawal in 2025/26 and had no other taxable income in both tax years, they would pay no income tax at all as both withdrawals would be below their £12,570 personal allowance.”
Choose your investments carefully
As you approach retirement, your investment strategy should match how you plan to access your pot. If you’re aiming for a drawdown, Mr Selby suggested ensuring your investments are diversified to avoid unnecessary risk.
Whereas those planning to buy an annuity could make sure they’re reducing exposure to riskier assets like equities.
Beware of scammers
Pension scams are on the rise, and Mr Selby urged caution. Some offer high-risk, unregulated investment ‘opportunities’ which often promise sky-high returns over short periods of time. Mr Selby said: “Such offers will often come with exorbitant fees and, in the worst-case scenario, will simply be out-and-out fraud, with a criminal taking your hard-earned retirement pot and scarpering.”
He advised people to be wary of unsolicited calls or emails offering ‘too good to be true’ investment opportunities, adding to “always deal with regulated companies” and be sure to verify any offers before committing.
Understand inheritance tax (IHT)
From April 2027, pensions could potentially be subject to inheritance tax (IHT), complicating matters for those wanting to pass on their pension to loved ones.
However, Mr Selby pointed out that the reforms are only being consulted at this stage. He said: “We don’t have final rules and legislation, and the Government has faced significant opposition to using IHT as the mechanism for taxing pensions on death. So, it is possible there will be changes to the proposed rules, which may impact any decision you take.”
Secondly and “crucially”, most people will not have to pay IHT at all. No IHT is applied to assets under an estate’s ‘nil rate band’ of £325,000. People’s estates may also benefit from the ‘residence nil rate band’ (RNRB). This is £175,000 and applies to a property left to a direct descendant. Mr Selby said: “If both these allowances are passed between a married couple, their estates could leave a combined total of £1million tax-free.”
Thirdly, if you die before April 2027, your beneficiaries can inherit your pension under the current rules, meaning IHT will not apply.
Mr Selby said: “If you’re still looking for ways to mitigate a potential IHT liability on your pension assets, you could consider gifting to loved ones while you’re alive. However, it’s worth speaking to a regulated financial adviser first to make sure this is in your best interests.”
Check your State Pension
The state pension will form the foundation of many retirees’ income, and Mr Selby recommended reviewing your National Insurance (NI) record to ensure you get the full rate. You need around 35 National Insurance (NI) years on your record to qualify for the maximum state pension.
Mr Selby said: “As you approach retirement, it’s worth checking your NI record to make sure you don’t have any gaps that could be filled, either for free by claiming NI credits or by paying voluntary NI contributions.”
Consider other assets
Finally, Mr Selby encouraged people to take into account other assets they may have.
He said: “If you have a significant defined benefit (DB) pension, for example, you might be comfortable taking larger withdrawals from any DC pensions you have. Equally, those with ISAs or property investments will need to factor those into their retirement income planning.”
