The dangers of DIY dipping: 2 important reasons to seek advice before taking your pension

If you are approaching retirement, you might already be thinking about how you will celebrate this milestone. A bucket list holiday, moving home, or simply celebrating with friends and family might all be on the cards.

When you retire, your defined contribution (DC) pension will likely make up a large portion of your later-life income. Yet while you’re planning for when you will begin drawing these hard-saved funds (and how you’ll spend them), you might not have given much thought as to how you’ll go about it.

Indeed, a November 2022 report from researcher JustGroup reveals that, in the 2021/22 tax year, 53% of the more than 700,000 DC pensions accessed for the first time were “DIY dippers” – meaning they were drawn without professional advice. In fact, only 1 in 3 private pensions were accessed after professional guidance was obtained.

Read on to find out two important reasons why being a DIY dipper could harm your retirement plans, and how we can help you get the most from your precious pension pot.

1. Seeking financial advice before a pension withdrawal could lower your tax bill

Most notably, seeking advice from a qualified Financial Planner can help mitigate your tax bill when you draw from a private pension.

Indeed, the milestone event of drawing from your pension pot could incur a weighty tax bill if you undergo this process uninformed.

Below are two examples of how you could take your pension for the first time, and how your decision-making may affect your tax liability.

• Taking your whole pension as a lump sum without consulting a Financial Planner first

You have worked hard all your life, and are finally able to sit back and relax. You plan to take your family on a celebratory holiday this year, and want to help your kids onto the property ladder in the coming years too.

So, when you retire, you decide to withdraw your entire large DC pension as one lump sum. That way, you have full control over your funds from day one, and can spend them however you like.

Only after you draw the funds do you realise that only 25% of your lump sum is a tax-free withdrawal. The remaining 75% was taxed at your marginal rate of Income Tax – meaning you could have paid up to 45% of that money straight to HMRC.

You still have a sizeable sum left to spend in retirement, but much of your pension wealth has been spent on an unnecessary tax bill.

Unfortunately, many individuals have emptied their pension pots without consulting an expert, often leading to this increased tax burden. According to the JustGroup research, 65% of full withdrawals in 2021/22 were done unadvised.

• Speaking to your Financial Planner before deciding on a pension withdrawal plan

Your retirement date is coming up. Like most people, you aren’t sure how to make the most of your private pension pot, so in preparation, you decide to book a pension review with a Financial Planner.

During your review, the Financial Planner:

• Looks at all the pensions you hold, and the value of each
• Asks questions about what you want to do in retirement
• Talks you through the retirement income options at your fingertips
• Explains how much tax you might pay on each income option
• Helps you come to a decision about how to take your pension tax-efficiently while still achieving your retirement goals.

Afterwards, you walk away feeling confident about your pension withdrawal plan. You might choose to flexibly access your pension, or, you could have chosen an annuity option, giving you stable peace of mind as you enter retired life.

Ultimately, your circumstances are unique – but one thing that holds true for many people is that taking your pension after seeking advice could decrease your tax bill.

Fortunately, talking through your options with an experienced professional before you take your pension can arm you with the knowledge you need to keep your tax liability to a minimum.

2. The cost of retirement is rising – so your pension pot needs to last

If you are set to retire this year, you might be worried about making your pension last through the cost of living crisis and beyond.

With inflation standing at 10.4% as of February 2023, your pension’s spending power could be dampened in the coming few years. In fact, FTAdviser reports the UK’s inflation rate is driving an 18% surge to the “minimum” cost of retirement – meaning your planned budget might not cover everything you’d hoped.

Looking even further down the road, there are significant later-life costs you may need to prepare for. For instance, the Office for National Statistics (ONS) reports as of 2020/21, 42% of State Pension Age individuals had a disability – and in an ageing population, the number is likely to increase over time. While the state can cover some of these care costs, you may need to prepare to foot a large care bill later in your retirement.

All this to say: when you access your DC pension without advice, you may not have sustainability on your mind. While your pension could help you pay for lots of exciting, big-ticket items now, it is important to have a long-term retirement plan in mind before you access (and spend) these funds.

Fortunately, using cashflow modelling software, we can help determine how much you may need to live on in retirement. This process could give you the confidence and knowledge to prepare for the cost of the coming decades.

Get in touch

If you are thinking about your retirement, working with us before you access your pension pot could have countless long-term benefits.

Email us at enquiries@pen-life.co.uk, or call 01904 661140.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The Financial Conduct Authority do not regulate cashflow planning.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

All information is correct at the time of writing and is subject to change in the future.