Pension Blog Series: Episode 4 – Why are more people turning to their pensions in the crisis?
In Episode 4 of our new Pensions blog series, we look why more people are turning to their pensions in the crisis.
Anyone with a defined contribution pension can currently access it from the age of 55 (increasing to 57 in April 2028), though most prefer to wait until they are bit older.
In addition to the usual reasons for wanting the money (e.g. retirement or semi-retirement), the coronavirus pandemic has resulted in two more.
- Those furloughed from their work or made redundant may need additional income and could see their pension pot as a possible solution.
- The stock market was badly hit at the start of the crisis, meaning that pension funds invested in equities will have lost a chunk of their value. Some pension policy holders may have been alarmed by this dip and hurried to move their money somewhere that they perceived to be ‘safer’.
There are indications that both these things have been happening. There are likely to be unwanted and unforeseen consequences for those accessing their pensions without taking the necessary advice.
The risks of making early pension withdrawals
The most obvious potential consequence of making early pension withdrawals is that a pension accessed sooner may well run out more quickly. If you planned to retire at 65 but start to take your pension at 55, the pot will have to last longer.
Even if accessing your pension early is only a temporary measure (e.g. needing extra money due to the impact of lockdown and stop as soon as you’re back to work) there is still an unfortunate side-effect. Once you start to access your pot (excluding the taking of your tax- free lump sum), you can no longer pay as much into your pension if you wish to add to it later. Your annual allowance (the total you can pay into all pensions per year) drops from £40,000 to £4,000. It is true that not many people pay in more than that in the first place, but for higher earners it can be restrictive.
The risks of moving your money out of your pension
Some might think it is a sensible strategy to move pensions out of more volatile investments and into a cash savings account, but there are in fact huge disadvantages in doing so.
- Withdrawing money after a crash ‘crystallises’ the loss, i.e. makes it real and irreversible, whereas leaving the funds invested would give them the opportunity to recover over time. Even the highest interest savings accounts cannot deliver the necessary level of growth.
- A pension is not like a savings account. Withdrawals (not including the tax-free cash entitlement) from a pension count as income, so are taxed as income. This means you face yet another loss at the point of withdrawal, further reducing any benefit from lower volatility.
- Your tax bill may be not just large, but excessively so.
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Other episodes in this series
Episode 1 – The impact of COVID-19 on pensions
Episode 2 – Reversing damage to long-term retirement plans caused by reducing or stopping pension premiums
Episode 3 – Gender pensions gap
Episode 5 – Lump sum losses: the tax hit of large pension withdrawals
The contents of this article are for information only and should not be seen as advice or recommendation to act. Always seek financial advice before taking action in respect of your pension planning.