Cashing in a pension pot
People accessing their pension as a flexible income has increased by 56% since the first lockdown. This increase is due to people withdrawing after holding off when stock markets were volatile. However withdrawals of all types still remain below 2019 levels. With businesses now shut due to the third lockdown, the prospect of further high numbers of withdrawals is possible.
Here’s some figures to show the scale of the withdrawal of funds:
- The number of people taking only a tax-free lump sum has increased by 55%
- The number of people withdrawing all of their pension in one lump sum increased by 94%. This increased by 51% during the same period in 2019.
- The number of people buying a guaranteed income for life (annuity) increased by 41%
There is a combination of factors that has led to this increase in withdrawals; one being some people returning to withdraw after pausing earlier in the year due to stock market volatility, and some people needing the money after a change in circumstances.
Laura Stewart-Smith, Workplace Savings Manager at Aviva said “Money may have been withdrawn to offset falls in income. Covid has, and will continue to, change lives and, in some cases, trigger early retirement or a decision to access funds early”.
Drawbacks to dipping into your pension pot
There are some tax implications to taking money out of a pot early. You can take 25% tax-free, but the rest will be taxed as your income for the year. You might then find yourself paying tax at 20%, 40% and possibly 45% on these withdrawals as you are pushed into a higher tax bracket.
Moreover an emergency tax may be applied to withdrawals. This means you will have to claim the tax back. This is a problem especially if you are budgeting and need an exact amount in your bank account.
At present, you can pay up to £40,000, or all of your salary, into a pension and get tax relief on the contributions. Taking money out early may affect tax reliefs on future contributions. If you withdraw more than 25%, the tax relief reduces.
Beware of fraud
Financial scams are on the rise and older people are among the most vulnerable, especially those who have just taken money from their pension. With many facing financial uncertainty as a result of the pandemic, they are especially susceptible to scammers who target them with fake investment schemes.
Take a step back
ABI’s Head of Long-Term Savings, Rob Yuille’s top tips on things to consider when withdrawing money from your pension:
- Familiarise yourself with the pensions freedoms so you are aware of your options. You can do a lot more with your pension pot than previously. What risks are you willing to take?
- Consider the amount of money you will need each month to maintain your lifestyle. Do you want to have annual holidays? Do you still have a mortgage to pay off? What other sources of income do you have, and do you need your pension to keep up with inflation? Could you consider working for longer?
- Think about costs later in your retirement. Care needs are not a subject we are comfortable thinking about but it is important to have conversations about it with your family, as well as powers of attorney, wills and inheritance.
- Your health and life expectancy. We often vastly underestimate this, but evidence shows we are mostly living longer, with a growing variation in healthy life expectancy. If you have a partner, do you need to provide for them financially after you die, or are you relying on them?
- Use sources of help: the government’s pensions tracing service if you think you might have a lost pension pot; a Midlife MOT from the Money and Pensions Service or your employer; and Pension Wise, or a financial adviser.