The FCA’s Financial Lives 2020 survey, released last month, has found that almost three in five (58%) of those who retired between March and October 2020 did so because of Covid-19.
The report blames lack of engagement in retirement planning, arguing that the unprecedented nature of the pandemic forced unprepared retirees to access their funds early.
While 18% chose to retire because the pandemic highlighted a need for change, for others (40%) it was financial insecurity that forced their hand. Ill health, job losses, or worries about their children’s finances all played a part.
Accessing a pension to alleviate financial difficulties might be the best choice in some circumstances and it is important to remember that those funds are there if needed. There are long-term consequences though, and lots to consider, so seeking advice beforehand is advisable.
Here are three reasons to avoid accessing a pension early, if it is affordable to do so.
1. The difficulty of budgeting long term
When Pension Freedoms arrived in 2015, the new rules gave retirees more choice.
Flexible options such as flexi-access drawdown and uncrystallised fund lump sums (UFPLS), now compete with the standard annuity option, putting pensioners in control of their own retirement income.
Flexibility has also meant increased responsibility, especially around budgeting.
Managing pension withdrawals is not easy and there are no “golden rules”. In the 1990s, when interest rates were high, 4% withdrawals might provide a comfortable retirement while allowing for further growth.
Currently, with interest rates at a historic low, 4% withdrawals might not be a reliable marker. Add periods of market volatility, such as those we saw in March 2020, to increasing life expectancies, and budgeting successfully for a thirty- or even a forty-year retirement looks increasingly difficult.
At Ermin Fosse, we use our knowledge and experience to help our clients manage their retirement income. There are some important things to remember:
- Spending in retirement isn’t static but can fluctuate.
- Withdrawing a consistent amount without factoring in stock market prices can deplete funds more quickly than expected.
- Taking more from a fund than is needed could leave money sat in cash, losing value in real terms when viewed against inflation.
Professional advice can make budgeting during a long retirement easier, providing confidence and peace of mind.
2. There are tax traps to avoid
Taking a pension as a UFPLS could release a large amount of cash in one go. This can lead to a change in an individual’s tax bracket and an unexpected bill.
A UFPLS also attracts emergency tax. This is because HMRC tax the payment on a “month 1” basis. This assumes the amount received is the first in a series of monthly payments of the same amount, effectively dividing the recipient's Personal Allowance by 12.
Although the overpayment can be claimed back, it is important to be aware of this, especially if the money has been earmarked for a time-sensitive purchase.
The biggest issue with taking pension funds earlier than planned is that the chosen pension option could trigger the Money Purchase Annual Allowance (MPAA).
The MPAA will usually trigger when:
- An entire pension pot is taken as a lump sum or when ad-hoc lump sums begin
- Funds are allocated to flexi-access drawdown and an individual starts to receive an income
- An investment-linked or flexible annuity is purchased.
The pension Annual Allowance is £40,000 (or 100% of pensionable earnings if lower). This is the amount that can be contributed to a pension each year while still receiving tax relief.
Triggering the MPAA reduces the Annual Allowance to £4,000. An individual’s ability to make future contributions – and benefit from the compound growth of a larger fund – will be severely impacted.
Clients looking to make pension withdrawals while continuing to contribute will need to think about their future plans, and whether their chosen option will trigger the MPAA. We can help with that so speaking to us is a good first step.
3. Scammers target those nearing retirement
One of the main pandemic-related reasons retirees accessed their pension last year, according to the FCA, was redundancy (23%). Other reasons included the need to shield or self-isolate (9%) or because of ill health (6%).
While the nature of the economic uncertainty last year was, for many of us, unprecedented in our lifetimes, it did highlight the need for financial planning.
An emergency fund and protection policies (income protection or critical illness cover, for example) gave individuals the confidence to stick to their original plans even when times were tough.
Those forced to alter their long-term plans to cover short-term gaps in income might have left themselves vulnerable.
Scams increased at the start of the pandemic. Action Fraud announced a 400% increase in reports for March 2020 alone. In the 12 months to October 2020, nearly a quarter (23%) of 55- to 74-year-olds received unsolicited approaches.
The uncertainty caused by the pandemic, with the added fear of money worries, could make spotting potential scams harder.
Those below age 55 (the current minimum retirement age) need to be vigilant too.
Many pension scams look to encourage those nearing retirement to access their funds early. Red flags to look out for include:
- Unsolicited contact (the government banned pension cold-calls in 2019 so any pension call out of the blue should be seen as suspicious)
- Time-sensitive offers designed to force a quick decision
- Unusual or high-risk investments such as overseas property
- Any mention of a “free pension review”, a “guarantee” or an offer to take a pension early.
Get in touch
With a long-term plan in place, aligned to your circumstances and goals, you will have confidence and a sense of control over your financial future, whatever that future brings.
You’ll still have important decisions to make. Please get in touch at firstname.lastname@example.org to find out how we can help.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
This article is distributed for information purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Ermin Fosse and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Ermin Fosse’s services.
Please contact us before you invest / disinvest. The past is not indicative of future results. When you invest you may not get back what you put in. Errors and omissions excepted.
Ermin Fosse Financial Management LLP is authorised and regulated by the Financial Conduct Authority Financial Services Register No: 197438