Six Ways to Make Your Pension Fund Last

Managing your pension fund in flexible drawdown

You have reached the day when you begin to ask your pension fund to pay you back for all the years you have been saving. How can you be sure it will last as long as you do? Well, there are no certainties, but here are a few pointers that may help.

Retire with enough in the pot

It might sound obvious, but people often underestimate how much they will need, and how long they will live. If you have saved up just a little more than you really need, then you should find the management of your money fairly hassle-free. Retire with a bit less than you need, and you may find it a constant headache – needing to squeeze absolutely the best return you can, possibly by taking more investment risk than you really want. You can end up trying to live on an ever-diminishing pot of money.

Draw a reasonable amount

It’s important not to ask too much of your pension fund – it isn’t a magic money tree. Clearly, if you draw 3% of its value each year, you have a much better chance of the fund lasting than if you draw 6% per year.

Understand ‘sequence of return risk’

This ugly piece of financial industry jargon refers to the fact that if your pension value falls significantly and you are drawing money out, you risk depleting the fund to the point that it struggles to benefit from a subsequent recovery.

If that happens in the early years of your retirement, you could find that your money is at greater risk of running out, you have to accept a permanently lower level of income, or perhaps forego taking income for a period of time while the value recovers.

On the other hand, if you start with a couple of years of decent growth, then your pension should be much more able to weather difficult market conditions – provided you don’t draw on it too heavily!

Invest wisely

Given the above, how do you minimise the damage that might be caused by bad investment markets while you are in retirement? You could keep it all in cash, but your pension may have to last for 30 years or more, and the cost of living is going to rise over that time. You’ll need to generate some long-term growth to fund the later years of your retirement.

Firstly, excessive investment risk should be avoided – a permanent loss of capital (as distinct from a temporary fall in value) would be disastrous for your pension. You are unlikely to have the chance to replace the loss with money earned. Be very wary of salespeople bearing promises of high returns in unconventional investments.

A balanced approach can be appropriate – cash and other low volatility, easily accessible investments to provide for your income payments in the short term, with good quality shares for longer-term growth.

Be smart about tax

Normally, income drawn from a pension fund is taxable, just as if you had earned it. Under flexible pension benefit rules, if you haven’t taken the full initial tax-free lump sum, you can deem that 25% of each payment is tax-free cash, and only pay tax on three-quarters of the income. In another fine piece of industry jargon, this is known as ‘Uncrystallised Funds Pension Lump Sum’ (UFPLS).

For example, if you are not yet receiving State Pension, and have no other taxable income, in any year you could draw ￡16,000 from the pension and pay no income tax at all. A quarter (￡4,000) is deemed to be tax-free, and ￡12,000 is income, but that is within the tax-free personal allowance.

Or, if you drew ￡30,000 before tax, with no other taxable income, under the same rule you would pay only about ￡2,000 income tax under current rules.

That aside, if you can afford to do so, it makes sense to keep your total taxable income below the higher rate income tax threshold (￡50,270 in 2022/23).

Consider securing some income with an annuity

Annuities have been somewhat unfashionable over the last few years, because of pension freedoms and very low annuity rates. The recent jump in UK interest rates has caused annuity rates to rise quite sharply, so they may be worth another look. Generally, the later age you start an annuity, the higher the return you get.

If you can get a decent rate from an annuity, then having that guaranteed income could allow you to draw proportionately less from the remaining pension. Of course, you give up some of your pension fund to buy the annuity, but if that means the remainder has more chance to grow over the years, then you could be better off in the long run.

Taking advice

Various pension and investment providers can give you the tools to manage your pension on your own.

However, a financial planner can help you make these important decisions, invest your pension according to your requirements, advise you on how best to meet your income needs and keep it all under review on an ongoing basis. We hope this should allow you to spend your time enjoying your retirement income, rather than worrying about it.

For more insightful articles, news, and views on managing your pension fund, visit Wise Investment.

This article is intended for information only and does not constitute advice.? All information is based on our understanding of current law and practice, which may be subject to change in the future.

Past performance is not an indication of future performance. Any investments you make and any income, can go down as well as up - you might not get back the full amount invested.

Wise Investments Limited is authorised and regulated by the Financial Conduct Authority, FCA no. 230553.