The number of individuals withdrawing lump sums from their pensions at the age of 55 has reached a post-pandemic high, reflecting a significant shift in retirement planning. Experts have raised concerns about the long-term financial consequences of these early withdrawals, as individuals tap into their pension funds sooner than expected.
This shift is being influenced by rising living costs and upcoming changes in inheritance tax regulations set to take effect in 2027. According to a report by MoneyWeek, this trend is expected to intensify in the coming years, potentially placing greater strain on individuals’ financial security during retirement.
A Sharp Rise in Early Pension Withdrawals
According to recent data, 120,000 individuals took a lump sum from their pensions at the age of 55 last year, marking a 10% increase from the previous year. The total value of these withdrawals hit £2.2 billion, a significant rise from £2 billion in 2023.
This increase is attributed in part to pressures such as the rising cost of living, pushing more people to access their pension pots earlier than planned.
The Impact of Looming Inheritance Tax Rule Changes
In addition to financial pressures, upcoming changes to inheritance tax (IHT) laws are likely to fuel this trend. Starting in April 2027, most unused pensions and death benefits will be included in an individual’s estate, making pensions less effective for passing on wealth.
As a result, many are expected to withdraw money early and gift it to loved ones to reduce their estate’s value and, consequently, their IHT liability.
The Risks of Withdrawing Early
Experts have raised concerns about the potential risks of early pension withdrawals. According to Andrew Tricker, director at Lubbock Fine Wealth Management:
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 People are living longer than ever so funding a retirement has never been more expensive – money withdrawn early will need replacing.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.
Tricker also added:
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.
Three Things to Consider Before Withdrawing Your Pension
Tom Selby, director of public policy at AJ Bell, highlights three key factors people should consider before accessing their pension funds early:
1. Risk of Running Out of Money in Retirement
Withdrawing too much too soon from a pension pot significantly increases the likelihood of running out of funds.
For instance, a 55-year-old with a £100,000 pension withdrawing £5,000 per year (adjusted for inflation) could see their fund depleted by age 80. Given the average life expectancy for a healthy 55-year-old is in the mid-80s, there is a considerable risk of running out of funds early.
Selby emphasised:
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.
2. Missing Out on Potential Investment Growth
Accessing a pension early often means missing out on the growth potential of investments.
If a pension pot is accessed early, funds may need to be held in cash for a period, resulting in lower returns over time.
For example, a £100,000 pension pot could grow to £148,000 by age 65 without withdrawals, compared to £133,000 if £10,000 is withdrawn at age 55.
3. Triggering the Money Purchase Annual Allowance (MPAA)
Taking taxable income from a pension triggers the MPAA, which drastically reduces the amount that can be saved into a pension with tax relief.
After triggering the MPAA, the annual contribution allowance drops to just £10,000, compared to the usual £60,000 limit. This reduction could significantly impact future retirement savings.
Selby warned:
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.
He also offered advice for those struggling financially:
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.
Careful Consideration is Key
While the pressures of rising living costs and upcoming inheritance tax changes may prompt early pension withdrawals, it is crucial for individuals to carefully consider the long-term implications.
Those considering accessing their pensions early should weigh the risks, including the potential for running out of money, missing out on investment growth, and triggering the MPAA.
