Pension decumulation: How to avoid these three expensive mistakes

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When you spend your whole life saving and investing in pursuit of a goal, it’s hard to believe it when you finally reach your destination.

So, if you are at the point of retirement and can’t believe you have finally made it, you are not alone.

Some new retirees even experience a sudden reluctance to begin the process of decumulation (or in simpler terms, start spending the money you have worked so hard to save). It’s difficult to work out what you can afford to do and whether your plans are sustainable.

When you stop working, you will draw your retirement income from several places, and it’s likely that your private pensions will be one of the main sources.

Your private pensions will come in one or both of these forms:

• Defined contribution (DC) pension. A pot of money that has been invested on your behalf by the provider, available for you to draw from as you wish. Once it’s gone, it’s gone. Most workplace pensions and self-invested personal pensions (SIPPs) are DC pensions.

• Defined benefit (DB) pension. Also known as a “final salary” or “career average” pension, this is a form of guaranteed income provided by your employer or former employer.

Most people have DC pensions, and the majority of the tips you’ll read about here pertain to those.

Your pension funds will provide the bedrock of your later-life income, but without careful management, you could end up making three common (and costly) mistakes.

Keep reading to learn the top three pension decumulation mistakes people make, and how to avoid them.

1. Taking a huge lump sum straight away

As of the 2025/26 tax-year, you can access your private pensions when you reach age 55. Regardless of whether you’re retiring at this age or still working, you will usually be able to access your money and start spending it.

But the truth is, if you want to get the most from your money, being careful about how and when you draw it is paramount.

Firstly, it’s wise to leave your pension untouched for as long as you can. If you’re still working at 55, it may not be constructive to start pulling funds from your pension just because you can.

Then, there is Income Tax to consider. You will read about this in more detail later on, but for now, here’s what you need to know in three bullet points.

• Drawing a large lump sum from your DC pension pot could incur an unnecessary Income Tax bill.

• This is because only 25% of your pot is usually accessible tax-free. You might have seen this referred to as “tax-free cash”. Above this, any amount you draw is subject to your marginal rate of Income Tax (more on this later).

• This system means that, in the majority of cases, taking your whole pension as a lump sum could mean you lose a large portion of it to tax – for no reason.

Another reason to be careful about taking a lump sum from your pension is inflation.

If you withdraw your entire pot and put it into an easy access savings account, this might sound like a smart move – after all, then you can access your money more easily.

However, inflation typically erodes the value of your cash over time. Even if your money earns interest, it’s unlikely that it will grow in line with, or faster than, the rate of inflation over the long term.

Whereas, drawing only what you need from your pension on an annual basis means the majority of your fund is left invested. While there is some risk attached to this, history tells us that it’s more likely to outpace inflation in a market environment than in the form of cash.

As such, taking a big lump sum straight away could be a big mistake for several reasons.

2. Drawing your pension fund too fast

So, you have entered drawdown and are taking your pension fund little by little. But how much should you be taking?

You might have heard of different “rules” to live by when drawing from a pension, such as the 4% rule. Coined by US finance expert, William Bengen, this is the theory that if you draw 4% of your fund each year while leaving the rest invested, you’ll have a sustainable income that lasts a lifetime.

However, the reality is slightly different. As the cost of living rises, and with most people needing to pay for their own care if they need it, living by the 4% rule could be a mistake. Plus, you might have additional wealth plans that this rule doesn’t consider – helping your kids onto the property ladder, for example, which could increase your outgoings significantly in those years.

One way to ensure you’re not taking too much of your pension fund too fast is to work with a financial planner or adviser. Through them, you will gain access to cashflow modelling, which is professional-grade software that enables you to forecast your financial future using data rather than vague estimations.

By entering your private pension information, along with other income sources like properties you own and the State Pension, the cashflow model can tell you what you can comfortably draw each year. It will consider important mitigating factors like inflation, investment risk and even the cost of care, if you wish.

While cashflow models aren’t a crystal ball into your future, this data-driven approach could help you gain peace of mind when decumulating your pension fund.

3. Ignoring tax

Earlier in this article, you read about why taking a massive lump sum from your pension could result in an unwanted Income Tax bill.

Even if you enter drawdown and begin taking a flexible income, you still need to make tax mitigation a priority. Otherwise, a big portion of your retirement fund could go straight to HMRC.

Remember:

• You can either spread out your tax-free cash withdrawals or take the whole 25% as a lump sum. It’s best to discuss each option with a professional as the benefits and drawbacks will depend on your goals and financial situation.

• Any amount above your 25% tax-free cash is subject to Income Tax at your marginal rate. This means that very large amounts could be taxed at the additional rate (45%).

• Your non-pension income is combined with your pension income for tax purposes. For example, if you are claiming the State Pension, taking an income from a rental property and drawing from your DC pension or receiving DB pension income, all this may be subject to Income Tax.

• Not all income is taxed in the same way. For instance, drawing money from an Individual Savings Account (ISA) is not taxable. However, selling business shares, your second home or non-ISA investments could result in a Capital Gains Tax and/or Dividend Tax bill.

Keeping tax and sustainability front of mind, and ideally discussing your position with a financial planner or adviser, may help you keep more of your hard-earned pension wealth.