As the effects of Covid-19 take hold, some pension scheme members may be considering drastic courses of action with regard to their retirement savings. For example, there may be a choice to be made between cashing in a pension pot and keeping a roof over your head. In such circumstances, there would be very little choice, but for others it is important to understand the bigger picture if they are thinking about cashing in pension early. This will ultimately come at a price and needs careful consideration and ideally, expert advice or at least guidance.
While the extension of the furlough scheme will undoubtedly help, there remains a number of people who are suffering financially and for whom the pressure to dip into retirement savings to cover immediate needs will be substantial. Indeed, HMRC reported that 347,000 people withdrew money from pension pots throughout July, August and September, an increase of 6% from the same period a year ago. This takes the total value of withdrawals from pensions since flexibility changes were introduced in 2015 to in excess of £37 billion, a figure which seems likely to go higher with a second lockdown now underway in England and severe restrictions also disrupting businesses throughout the rest of the UK.
There is much to consider for members thinking of cashing in their pension early, not least:
- Beware of scams. While the industry is continuing to develop protections, scams are on the rise. And those who have recently taken money out of a pension pot could be targeted with fake investment opportunities.
- There are tax implications. Not only will 75% of the pot taken typically be taxed as income, but it will be added to other earnings potentially pushing some individuals into a higher rate tax band. It could also affect an individual’s ability to rebuild their pension pot as their limit on tax relievable pension savings could be reduced.
- There might be a knock-on effect on other benefits.
- One of the reasons pension pots grow is through the power of compound interest, a topic Warren Buffett returns to each year in his annual letter to shareholders. Withdrawing money from a pension pot means missing out on potential future growth on that money, requiring significant additional future contributions to get back to the position the member would otherwise have been in.
- Will there be enough left to last through retirement? Most people live longer than they expect, which means the prospect of running out of money if proper planning isn’t done. In a recently published report, entitled Planning for your future: Financial clarity in an uncertain world, 33% of 35 to 59 year olds and 64% of those aged over 60 say they will be reliant on the State pension to fund their retirement. At £175 per week for the full new State Pension, this represents around only 30% of average UK earnings of £585 per week.
While we are hopeful that we can now see a way out of the pandemic through vaccinations, the effects on the global economy, including mass unemployment, are still unfolding. Undoubtedly, there will be many more individuals looking for a financial buffer and they may turn to their retirement savings. For the industry to ensure best possible outcomes for all members, we must make sure that the impact of early encashment of pensions is made clear to those who may be considering this option. Before doing anything drastic, members considering early access should start with a free appointment with PensionWise.