A survey has found that many retirees are taking advantage of Pension Freedoms to splurge on luxuries as they enter retirement. But without a financial plan in place, they could be placing their future security at risk.

Once you reach the retirement milestone it’s common to want to indulge and kick off the next chapter of your life with a celebration. Whether you’re planning a trip abroad, want to make an extravagant purchase or invest in a hobby, wanting to spend some extra cash at the beginning of retirement is normal. However, splurging needs to be balanced with an understanding of how your retirement provisions will support you for the rest of your life.

A Department of Work and Pension survey found:

  • 36% of those approaching retirement that hadn’t taken advantage of government-backed pension guidance said the main thing they had spent their withdrawn pension on was discretionary purchases, such as a holiday or new car
  • This falls to 14% among those that had an appointment with Pension Wise before making a decision

The findings highlight the value that advice can provide, helping retirees to look at the long term when spending their hard-earned savings.

What’s more, 65% of those that had an appointment with Pension Wise went on to seek further expert advice within three months, speaking to either a financial adviser, tax adviser or accountant. The findings suggest that many retirees that benefited from government-funded advice initially saw the value of continuing to engage with finance professionals. In contrast, just 23% of those that didn’t benefit from Pension Wise guidance sought expert support.

Of course, taking a long-term view of your finances doesn’t mean you can’t make some bigger purchases when you first enter retirement. It’s about using Pension Freedoms to create an income that suits you now and in the future.

What are Pension Freedoms?

In 2015, the government announced changes to how pensions could be accessed. The aim was to give retirees more flexibility, allowing them to take an income that suited their lifestyle. However, there is a risk of overspending in early retirement and running out of funds in later years. It can be complicated to decide what to do, as there are many options:

  • Purchase an Annuity: You can use the money saved in a pension to purchase an Annuity. This will provide you with a guaranteed income for life, which may be linked to inflation. It’s an option that doesn’t provide as much flexibility as alternatives but in return, you have added security.
  • Use Flexi-Access Drawdown: If you use a Flexi-Access Drawdown product, your money will remain invested. You’re then able to withdraw flexible amounts, adjusting to suit your lifestyle. You will be responsible for ensuring you take a sustainable level of income, and investment values can decrease.
  • Take out lump sums: You can also choose to withdraw funds from your pension as a lump sum, you can even choose to withdraw your entire pension this way. Usually, only the first 25% will be tax-free and you should have a clear plan of how you’ll use the money to create an income if needed.
  • Leave your money in your pension: You’re under no obligation to use the money saved in your pension; it can remain there as long as you want. This may be the right option for you if you’re still earning an income or have other assets you wish to use first. A pension can be a tax-efficient way to pass on wealth too.
  • Hybrid approach: Many retirees are using Pension Freedoms to create a hybrid approach of the above options to suit them. You can mix and match the options to create a retirement income that suits your aspirations and priorities.

Can you afford to indulge in some luxuries?

With Pension Freedoms and the risk of running out of money in retirement in mind, could you afford to splash some cash in early retirement? What you spend in the first few months and years of retirement could impact your income for the rest of your life.

Carefully considering these key areas before you make a decision can help you assess your financial situation in retirement. With the right approach, you can knowingly indulge in luxuries without worrying about how it will affect your financial security in the future.

  • Annual income needs: To begin with, you should calculate the cost of essential spending, creating a base income level that you need. It should cover areas such as utility bills and grocery shopping, as well as some everyday discretionary spending. This helps you to create a minimum income your pension needs to generate annually.
  • Lifestyle spending: Would you be happy to splurge during early retirement and then live off the figure calculated above for the remainder? If the answer is ‘no’, you should work out what the difference between the minimum income needed and that for you to achieve your retirement goals.
  • Life expectancy: The two above figures will have little use if you don’t consider your life expectancy. It’s common for people to underestimate how long they’ll live. It’s a mistake that could leave them financially struggling in their later years. Of course, there are people who outlive the average life expectancy too, would you be able to afford necessities if this was the case?

If you’re approaching retirement and want help to better understand your finances, please contact us.