Pensions experts are warning over-55s against using their retirement savings to see them through the cost-of-living crisis.
Inflation soared to 9% in April as a result of the escalating price of food, fuel and transport, putting a squeeze on finances for many households. Those able to access their pension pots could be tempted to take out money to cover immediate costs, but this comes with the risk of having significantly less income in the future.
“As the cost of living squeeze continues to tighten, inevitably more people will be tempted to take more from their pension, or to start taking an income sooner than they’d planned, even if they’re still working,” says Steven Cameron, a director at Aegon, one of the UK’s largest pensions providers.
Legal & General said it had seen an increase in investors withdrawing from their funds this year compared with last and was “monitoring closely” whether this was due to the rising cost of living. In the first four months of last year, 5% of pension customers made an ad hoc withdrawal; this year, 18% did. “It is inevitable that with the cost-of-living crisis biting, people will be more likely to access their savings earlier and then draw down at higher rates,” says Emma Byron of Legal & General Retirement Solutions.
Since reforms made in 2015 by then chancellor George Osborne, savers have had easier access to their retirement money after the age of 55. Instead of being limited to a 25% lump sum, they have been able to draw down as much as they want from their fund.
Figures from HM Revenue and Customs show that in the last three months of last year, 428,000 people had withdrawn a combined £2.69bn from personal pension savings. Earlier this year Interactive Investor, the online trading platform, said its customers had withdrawn an average of £1,944 in January, up 25% on the same month in previous years.
Helen Morrissey of Hargreaves Lansdown said the increase in the energy price cap on 1 April was a landmark point after which the cost-of-living crisis became apparent to households.
Still working and invested
Pensions are there to ensure that you are financially secure for your retirement years. But investors who withdraw sums from their pot could see this future security threatened if they eat into their funds too early.
Withdrawing money early will reduce how much you ultimately have when you retire because you will lose out on potential for growth.
For example, a person with £100,000 in their pot at 55 can, if they don’t pay in any more, expect to see it to grow to almost £165,000 by the time they reach 65, based on annual growth of 5%. But if they take £25,000 out at 55, bringing the pot down to £75,000, it could subsequently grow to only £123,000 – a potential loss of £32,000.
Taking money out of a pension has implications for over-55s: they can take out a cash lump sum of 25% tax-free, but any money accessed after that will be taxed as income for that year.
Withdrawing money may also have an impact on the amount you can continue to pay into the defined contribution pot, should you be in a position to top it up later.
Under current rules, you can pay up to £40,000 into a pension and get tax relief on those contributions. However, taking out a series of lump sums from your pension, can trigger the Money Purchase Annual Allowance (MPAA), which reduces the amount that can be paid into a pension pot with tax relief to £4,000. The MPAA is also triggered by other scenarios – such as if you take the whole pension as a lump sum.
Rebecca O’Connor of Interactive Investor has called for an increase to the £4,000 MPAA. “This would allow those aged 55-plus who have accessed their pension but are still working to contribute more and get more tax relief, allowing them to get their pension into as healthy a state as possible before they eventually retire,” she says.
If you have already retired
Many have planned their retirement based on steadily drawing down from their pot. But withdrawing money faster to deal with daily bills will change all that, says former pensions minister Steve Webb, who now works for pension consultants LCP.
“You really don’t want to be doing that at the start of your retirement,” he says. “It is one thing doing it when you are 80 but doing it when you are 65 is quite different.”
There are, however, ways to avoid dipping into pension pots.
Pensioners on a low income may qualify for pension credit, which Morrissey says is a “hugely underclaimed benefit”. Pension credit tops up the income of the poorest pensioners and can be a gateway to other benefits, such as help with council tax, utility bills and mortgage interest.
“Pension credit is plagued by myths that prevent people from claiming it,” she says. “Many people believe you do not qualify for pension credit if you have savings or own your own home. Neither of these things is true, so it’s worth checking to see if you qualify.”
There have already been calls for the state pension to be increased in the next budget, but this could come too late for many. Webb says: “Saying to someone who can’t afford their energy direct debit or who is cutting back on food shopping to ‘just wait till the autumn’ is unacceptable. We will see excess deaths because some people can’t afford to get by.”
The 2015 reforms led to fewer people using their pension pot to buy an annuity, because of the relatively low income they got for their savings. Retirees on fixed-income annuities will be particularly badly affected by rising inflation. Webb says that while there are annuity products that track inflation, they are so expensive that few buy them.