Retiring early is a dream that many people share. It can allow you to do more of the things you love while you’re still young, fit and healthy. But have you ever considered the impact this could have on your pension?
How can early retirement affect your pension?
A good pension is essential for a comfortable retirement. So, naturally, no one wants to see theirs run out. However, new data from investment platform AJ Bell shows that this is the exact risk that those considering early retirement face.
According to Laura Suter, head of personal finance at AJ Bell, retiring early by 10 years can reduce the life of your pension by up to 25 years! Or it could mean that you accept a significantly lower payout from your pension (up to 40% less) to make it last longer.
This problem is particularly prominent with smaller pension pots. Here’s an illustration:
- The average pension pot in the UK is £91,000 according to The Investing and Saving Alliance (TISA).
- If you were to withdraw £10,000 annually from the pension starting at 55, your pot would run out by age 67, which is around State Pension age.
- If you wanted to make your pension last until you were 90, you would have to take a significant pay cut. More specifically, you would have to limit your withdrawals to just £4,900 per year.
What if you have a bigger pension pot?
You might have more leeway with a bigger pension pot. However, you would still need to take a pay cut if you needed it to last until you were 90.
For example, if you had a pension pot worth £200,000 and decided to retire at 55, taking a £15,000 annual income from it would see your pot only last until you are 75.
However, if you were to push back your retirement by five years and allow your pot to grow during that time without necessarily adding anything, it could last you until age 84 (assuming annual growth of 4%).
And, if you retired at the standard retirement age of 65, your pension would have more time to grow and, as a result, it could last you until you are 100, which is 25 years longer than retiring at 55.
So, if you want to retire early but have your pension last until you’re 90, you’ll have to take a pay cut. For example, if you retired at 55, you would need to take a pay cut equivalent to £7,250 per year. And if you retired at 60, you would need to cut your annual withdrawals by about £4,500.
What can you do to comfortably retire early?
If you’ve got a pension and are thinking of retiring early, then it’s worth taking the time to look at how this will affect your pension. If you are still in your 20s or 30s, then you’ve still got time to make your dream of early retirement a reality.
Here are two actions you can take right now to move closer to achieving your goal.
1. Increase your contributions to your workplace pension
You can boost your pension by increasing your contributions to your workplace pension.
When you increase your contributions, some employers will also increase what they pay in. Furthermore, additional contributions to your pension can provide an additional boost to your retirement fund in the form of tax relief.
Over time, this can make a huge difference to your pension pot. It could, in fact, allow you to retire early quite comfortably.
2. Make your other savings or investments work harder for you
Apart from your pension, you might also be saving for your retirement in other ways.
For example, you may have some money in a savings account. Check whether you are really getting the most of your savings and if there are other ways to make your money work harder for you.
Though relatively riskier, investing some of your money in the stock market through a tax-efficient savings vehicle such as a stocks and shares ISA has the potential to deliver better returns on your money over the long run.
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About the author
Sean is a personal finance writer with a strong passion for helping others become more financially literate and make better financial decisions. He covers everything from credit cards to savings to investing.
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