Making your savings last for a carefree retirement

The pension landscape has undergone a significant transformation in the last 20 years. Once, the gold standard for retirement was a Defined Benefit (DB) scheme, guaranteeing a stable, predictable income for life. 

However, the security offered by DB pensions has become increasingly rare, with their prevalence declining by roughly 3% per year. Companies have shifted away from DB schemes primarily to reduce costs and liabilities. 

Simultaneously, changes in government pension policy, notably the Pensions Freedom Act in 2015, have meant that people were provided more flexibility in accessing their savings from their Defined Contribution (DC) pensions – where the final pot depends on contributions and investment returns, not a guaranteed income like DB – making annuities seem more rigid and expensive. 

Retirement has changed – and so have the risks

Defined Contribution schemes are now the dominant pension product in the UK, and while they provide more flexibility, they also come with more responsibility for the individual to plan accordingly for retirement. Various factors threaten retirement savings, highlighting the importance of having a robust plan. 

People are living longer – in the last 40 years we have seen that life expectancy has increased by 8 years within the UK. On top of this, the cost of living is increasing over time, with most recently inflation hitting 11% in 2022, eroding the purchasing power of savings.

More turbulent markets over the last few years with Covid and various geo-political events have exposed savings to more volatility, meaning ill-timed withdrawals can damage the long-term viability of retirement funds. 

While proper planning can mitigate these risks, understanding your DC pension drawdown options is the first step.

Understanding your pension drawdown options

Each person is restricted from accessing their pension until they reach the normal minimum pension age, which is currently age 55, but it will be increasing to age 57 in 2028. 

Once pension age has been reached there are three main ways that people can withdraw from their pension. 

The first is to take your pension commencement lump sum, which is where you can take 25% of your pension pot tax free. This tax-free sum can be taken as a single lump sum or in stages, depending on personal circumstances. This could be useful to paying off a mortgage for example, however, careful consideration of its impact on future cash flow is essential.

Once exhausting the tax free portion of the self-invested personal pension (SIPP), a type of personal pension offering wider investment choices and control, you typically see that people enter flexi-access drawdown. Here, the remaining funds are normally drawn as regular installments (monthly, quarterly, or annually), with these withdrawals taxed as income at your marginal rate. The funds remaining within the SIPP continue to be invested with the potential for growth.

Alternatively, most providers like us offer an Uncrystallised Funds Pension Lump Sum (UFPLS) which allows for ad-hoc lump sum withdrawals directly from your untouched pension. This allows you to take ad hoc lump sums from your pension where 25% of the withdrawal is tax free and 75% of the withdrawal is taxed at your marginal rate of income tax. This option can be useful if you prefer not to crystallise a large portion of your pension at once and only require occasional lump sums for a specific purpose, like paying off a smaller debt or making a large purchase. Crucially, taking any UFPLS (as it includes a taxable element) will restrict future pension contributions.

You could also trigger the Money Purchase Annual Allowance (MPAA) when you take taxable income from your pension. This means that you become restricted in the amount of further contributions that you can make to your pension pot and benefit from tax relief. Each person’s pension allowance is either £60,000 a year or their annual pre-tax income whichever is lower, but after the MPAA is triggered, the allowance drops to only £10,000 a year. Not only does your pension allowance reduce, but you also lose the ability to carry forward any unused pension allowance from the previous three tax years. So if you expect to make a large contribution to your pension further down the line, from a bonus or sale of a company for example, then you would lose this option. However you should note that tax treatment depends on your individual circumstances and may be subject to change in the future.

A holistic and flexible drawdown strategy

Crafting an effective drawdown plan begins by acknowledging there’s no one-size-fits-all solution. Your strategy must be deeply personal, driven by your unique income needs, other income sources like the state pension, health, and legacy goals. 

This understanding then informs a holistic approach, looking beyond just your SIPP to strategically draw from all available savings – including cash reserves, ISAs, and General Investment Accounts (GIAs) – at different times. 

For instance, drawing carefully from a GIA can utilize your annual Capital Gains Tax allowance, while a timed UFPLS from your SIPP might ensure the taxable portion falls within your personal allowance, significantly extending your funds through smart tax planning

Retirement planning doesn’t end once a strategy is in place; a dynamic approach is essential. Retirement spans decades, evolving with personal plans and market shifts, making adaptability key.

It’s a misconception that retirement investments should be ultra-conservative. With longer lives and rising costs, your SIPP must be in a portfolio capable of beating inflation in the long term to maintain purchasing power and extend fund longevity. This requires full diversification across asset classes, global geographies, and industries to mitigate concentration risk, all while suiting your evolving risk tolerance and time horizon.

The graph below illustrates this point and shows the performance of our Active Regular P4 portfolio (green) compared to inflation (CPI, blue) and having the money sitting in cash (SONIA interest rate, red. SONIA is used as a benchmark for interest on cash, and is the average overnight interest rate banks pay to borrow sterling from other financial institutions). You can see that any money sitting in cash loses value over time as evidenced by its lower growth rate, and so keeping investments beating inflation in the long run can be key to retaining the purchasing power of your savings.

Past performance is not a reliable indicator of future results.

No matter how meticulous you have been with creating your plan, it is essential that you allocate the appropriate time to review your plan each year to ensure that you are on track to meet your goal. Regular reviews can aid in extending the longevity of your savings in retirement. Are you spending more than you have budgeted? Are markets delivering the returns that you have projected? Have your personal circumstances changed? These are all questions that need to be considered, and depending on the circumstances, being flexible and having the ability to reduce withdrawals in a more challenging environment can be powerful in making your savings last. 

Withdrawing money from your pension during a market downturn can significantly reduce how long your savings last. For example, imagine two retirees with identical pensions of £400,000, both withdrawing £8,000 a year. They both take a lump sum of £100,000 – but the timing is crucial.

The graph below shows that if a lump sum is taken at the bottom of a market crash, say at age 63, the pension runs out by age 78.

However, if the same lump sum is delayed until age 66 – after the market has had time to recover – the pension lasts until age 89.

This stark contrast shows just how damaging poor timing can be. Using cash reserves or reducing withdrawals during downturns can make a meaningful difference, giving your investments time to recover and extending the lifespan of your retirement income.

Why expert guidance matters in retirement planning

The flexibility of SIPP drawdown is a significant advantage, yet it comes with inherent complexities. Successfully navigating this landscape means actively avoiding common pitfalls that can derail even the most well-intentioned plans. These include the danger of withdrawing too much too soon, which places immense pressure on your remaining capital to sustain you. 

Equally, ignoring the persistent threat of inflation by, for example, holding excessive cash or adopting an overly conservative investment stance can steadily erode your purchasing power over time. Perhaps the most common oversight is failing to regularly review and adapt your plan; retirement is a long journey, and the financial landscape, market conditions, and your personal circumstances will inevitably evolve.

Given these challenges, and the profound impact of getting drawdown decisions right, seeking professional financial guidance is strongly recommended. Ultimately, professional guidance can provide the clarity and confidence needed to transform your hard-earned savings into the secure and fulfilling retirement you desire.