After years, or even decades, of building up your pension and investments, you eventually reach the point where you want to start drawing from these savings. This marks the transition from the accumulation phase of your financial life to the decumulation phase.
Five Essential Rules for Drawing on Your Investments and Pension
By Portugal team
This article is published on: 4th October 2024
Navigating this phase effectively can make a significant difference to your financial well-being and your legacy. Below, we outline five key rules to help ensure that your withdrawals are both tax-efficient and investment-savvy.
1. Only withdraw your lump sum if necessary
Under UK pension rules, you can withdraw 25% of your pension fund tax-free. This is known as the “Pension Commencement Lump Sum.” Whilst this payment is tax free for UK residents, those living in Portugal must report and pay tax (unless 0% NHR) on this sum.
If you have a specific plan for this money, such as paying off a mortgage or clearing other debts, withdrawing the lump sum may be a wise choice. However, if you don’t have an immediate need for it, it might be better to leave the funds in your pension, where they can continue growing tax-free.
Another key consideration is inheritance tax (IHT). Currently, pension funds are exempt from UK IHT. By taking money out of your pension, you may unintentionally move it into your taxable estate. This is fine if you plan to spend the funds, but it could be inefficient if you are simply holding on to or reinvesting the cash.
2. Dynamic withdrawals
When withdrawing from your investments, striking the right balance between enjoying your lifestyle now and securing your financial future is crucial. Some people prefer to prioritize their current lifestyle, while others aim to leave a larger estate for their beneficiaries.
Market conditions should also influence your decisions. For instance, if stock markets have risen, it might be wise to take profits. Conversely, during market downturns, you might choose to reduce your withdrawals until conditions improve.
Cashflow planning can also help you plan for the future. Forecasting allows you to balance your spending today with the need to preserve funds for the future. It also allows you to adjust for variables like inflation, market performance, and unexpected expenses, helping to prevent the risk of outliving your savings while maintaining your desired lifestyle.
3. Plan for the long haul
Many people underestimate their life expectancy when planning for retirement. A couple in their mid-60s today has a good chance of living well into their 80s or even beyond 100. This means it is important to plan (and think in) decades rather than just a few years.
This increased longevity has important implications for how one should invest. In the past when life expectancy was much shorter, retirees often moved their portfolios into lower-risk assets like bonds or cash but with people living longer, this approach is no longer be suitable.
To ensure long-term growth, it’s essential to maintain a healthy allocation of growth-oriented assets such as shares, while balancing this with safer investments like fixed income and cash. The exact mix will depend on your risk tolerance and other income sources.
4. Review Your Plan Regularly
Global markets and tax laws are constantly changing, which is why it is crucial to review your portfolio regularly against this ever-changing backdrop.
This includes keeping up with changes in tax laws across multiple jurisdictions, for example UK pensions has seen huge changes recently and further changes are expected in the next UK Budget. Adapting to new rules in both the UK and Portugal, can help you avoid costly mistakes and optimise your financial strategy.
5. Control Fees and Taxes
While you can not control market movements, you can manage two major eroders of wealth: taxes and fees.
People often end up paying tax in the wrong country or, worse, in multiple countries at once. Additionally, many fail to take advantage of the tax reliefs and allowances available to them.
Regularly reviewing your financial arrangements can help ensure that your investments and pensions are tax-efficient and that you are not overpaying in fees.
Final word
By following these five rules, you can better navigate the transition to decumulation, ensuring that your hard-earned savings continue to work for you in a tax-efficient and financially secure way.