Money Box on pensions
Savers are free to start raiding their retirement pots once they turn 55, under pension freedom reforms introduced in 2015.
Millions dip into their pension every year and their numbers are rising thanks to the cost-of-living crisis.
There is absolutely nothing to stop them from taking all their pension if they wish at 55, and blowing the lot.
It’s their money, their choice.
Which sounds great until the money runs out and suddenly they’re broke.
I have repeatedly warned of the danger of making early pension withdrawals, and warned right at the start that pension freedoms could backfire horribly.
Pensions are designed to last for life, and with a typical retirement lasting for 20 or 25 years, that’s a long time.
I warned back in 2015 that huge numbers would blow their savings then fall back on means-tested state benefits like pension credit, costing taxpayers a fortune.
Last year, the Financial Conduct Authority admitted that a “spend, spend, spend” attitude has taken hold, and millions risk leaving themselves short of money in later life.
Most have little choice. It’s impossible not to spend, spend, spend these days, simply to cover essentials like food and fuel.
The risk is still the same, though.
City watchdog the Financial Conduct Authority (FCA) has called the trend to cash in pensions “the new norm”.
Many are tempted by the fact that they can take 25 percent of their pot as tax-free cash (although the remainder may be taxable).
Large numbers consider the money a “windfall” and are motivated by a perception that “everyone is doing it”, the FCA added.
Prior to 2015, pensioners were obliged to buy an annuity at retirement. Annuities have their faults but they pay a guaranteed regular income for life, no matter how long you live.
The majority of pensioners continue to shun annuities, yet they pay a lot more like income than just 18 months ago.
Instead, they leave their retirement savings invested via drawdown, and take income and lump sums as required.
The problem with drawdown is that there is no guarantee the money will last, far from it. Draw too much and it will eventually vanish.
This is a particular worry today, as people raid pensions that have already been depleted by stock market volatility.
Another big challenge is that the over-55s are in the dark over how much they can safely withdraw, which makes mistakes even more likely.
One year ago, the FCA found that more than two in five savers who were making regular withdrawals took eight percent of their pot’s value each year.
That’s a disaster in the making and here’s why.
There’s a long-standing financial planning rule of thumb, known as the four percent rule. This states that if you take four percent of your pension each year as income, your savings will never run dry.
The rule assumes that the long-term average return from share price growth and dividends is seven percent a year.
So if you take four percent your pension and income should still rise by three percent a year, protecting them from inflation.
Lately, some have argued that it should be amended to the five percent rule, but either way, that’s well below eight percent.
It means that almost half of all those withdrawing money are taking twice as much as they should. I call that an unsafe withdrawal rate.
The FCA figures were prepared before inflation took hold. I dread to think how much the over-55s are taking today.
It’s a drawdown disaster in the making, and we’ll all pay for it.
Pensioners who want their money to last must work to rule – the four percent rule. It won’t be easy, given how little most people have, and how fast prices are rising today.
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