24th August 2020
With many household incomes under pressure following the impact of coronavirus, it may be tempting for those aged over 55 to consider withdrawing from their pension early. However, as well as reducing their future retirement income, individuals accessing their pensions have much to think about as there are other serious risks such as paying more tax than necessary, falling victim to a scammer or making unwise investment choices.
To help avoid this, Jonathan Watts-Lay, Director, WEALTH at work, a specialist provider of financial education and guidance in the workplace, has outlined the top five things to think about before withdrawing from your pension.
1. Understand the tax implications
You can end up paying 200 times more tax depending on the way you decide to take money from your pension, according to the Pension Policy Institute (PPI) Evolving Landscape report. This is because it is possible for people who have been basic rate tax payers all their life to suddenly become a higher rate tax payer, if the amount they withdraw from their pension (in addition to any other income that year) is more than £50,000.
2. Consider using other assets
If you have other taxable savings and investments, these might be a better place to start when looking for extra money, rather than the tax-free environment of your pension. Also, if you take money out of your pension, but are still working, you may fall foul of the Money Purchase Annual Allowance (MPAA). Triggering the MPAA will mean you will only get tax relief on the first £4,000 you contribute to your pension. Any contributions made above this limit will be subject to income tax, making it very difficult for you to rebuild your pension pot.
3. Don’t underestimate how long you will live
Before withdrawing from your pension, it is crucial to think about if you will have enough money to last throughout your retirement. Most people live longer than they expect to, which means that they may not save enough whilst they are working. In fact, the Institute for Fiscal Studies found that those in their 50s and 60s underestimate their chances of survival to age 75 by around 20%, and to 85 by around 5% to 10%. For example, men interviewed at age 65 believed they had just a 65% chance of reaching age 75, but the official estimate is 83%. Also, according to the Office for National Statistics, a 65 year old male and female have a 1 in 4 chance of attaining age 94 and 96 respectively. This means your money may have to provide you with an income for almost 30 years!
4. Defined Benefit (DB) v Defined Contribution (DC)
£10bn was transferred out of DB schemes into DC funds during the last three months of 2019, £32bn during the whole year, and £127bn in the last five years, according to the Office of National Statistics.
Pension transfers are complex and there are many things for you to consider before making any decisions, including whether the transfer value being offered represents good value, and whether you understand the many secure benefits you will be giving up, as well as the risks associated with a transfer.
Regulated financial advice must be sought to transfer a DB final salary pension if its value is £30,000 or above. However, the FCA has warned that DB pension transfer advice is often substandard. Less than half of the transfer recommendations reviewed by the FCA in 2018 were considered right for the customer.
Speak to your employer to find out if they can recommend a trusted advisory firm, who has appropriately qualified and authorised advisers, an exemplary regulatory record and transparent and fair pricing, to help you to decide what is right for you.
5. Life savings lost to pension scams
Individuals getting scammed out of their retirement savings is a real issue. Findings from the FCA and The Pensions Regulator show that victims of pension scams could lose 22 years’ worth of savings within 24 hours.
Scams have also been on the rise following the coronavirus outbreak. Action Fraud has reported that over £11.3m has been lost to coronavirus-related scams; with pensions and investments being a major target.
Whatever you’re planning to do with your retirement savings, it’s vital to check whether the company that you’re planning to use is registered with the Financial Conduct Authority (FCA). You can also visit the FCA’s ScamSmart website which includes a warning list of companies operating without authorisation or running scams.
Jonathan Watts-Lay, Director, WEALTH at work, concludes;
“People spend most of their working life saving for their retirement, so it is a big decision how and when they withdraw money from their pension, and it needs to be carefully thought through. There is a lot at stake but with some careful planning you can make sure that you don’t pay unnecessary tax, use the right assets for income at the right time, and ultimately make educated decisions on what is right for you. If you are not sure, or need help with understanding your options, it is important that you do your research, and get regulated financial advice if needed.”
He adds; “Many organisations recognise that their employees may need help with their financial planning as they approach retirement and are putting support in place. It is worth speaking to your employers to find out what help is available.”