Pensions  

Is the 25 per cent tax-free cash leading savers astray?

Romi Savova

Romi Savova

For many savers, the opportunity to withdraw 25 per cent of their pension tax-free as soon as they turn 55 is an attractive proposition that’s often too good to resist

Increasingly, pensions are becoming disconnected from retirement with people accessing their pensions earlier than necessary, surrendering valuable guarantees and reducing their long-term returns. 

PensionBee recently analysed the barriers and challenges faced by those making plans to access, and at the point of accessing, their defined contribution pension. It found approximately one in five savers would withdraw their pension simply "for control".

This often means moving it to a savings account, earning little interest, or other investments.

This is particularly concerning now that the UK has officially entered recession, as the exact moment a saver accesses their pension can have a big impact on their ultimate retirement income.

Withdrawing money they don’t intend to spend straight away during a downturn could risk depleting their pots to a level unlikely to last through retirement. 

In addition, more than half of those surveyed said they found decisions about pensions and retirement income daunting and complex, with 28 per cent being put off retirement planning altogether as they were afraid of making the wrong decision.

Despite this, only one in 10 had been contacted by their pension provider with an explanation of how the pandemic might affect how they could access their pension, while just 7% had been told by a provider to seek impartial advice or guidance before accessing their retirement savings.

Reversing the dash for cash 

Over the years, 25 per cent tax-free cash has become a strong anchor, with many savers mistakenly thinking they should withdraw a quarter of their pension as quickly as possible, even if they do not have a need for it or a plan for what to do with it.

Where savers are accessing their pension without taking independent advice or guidance, unrealistic expectations of income, driven by high expectations of potential returns and low expectations about life expectancy, and therefore how long their pension needs to last, are going unchecked.

It has made savers complacent about their retirement income and ultimately facilitated bad saving behaviour, with the expectation of 25 per cent tax-free cash acting as a gateway to further withdrawals. 

According to the latest figures from HMRC, over £37bn has been flexibly withdrawn since 2015, with four in 10 flexible income withdrawals at an unsustainable annual rate of 8 per cent and over.

Through no fault of their own savers simply don’t understand what represents a sustainable withdrawal rate, and if they continue withdrawing at the same levels during a market downturn without intervention, it’s highly likely they will run out of money. 

Covid-19 has delayed the implementation of the FCA’s investment pathways rules which are designed to help savers ensure they are in an appropriate investment product based on their pension withdrawals and retirement objectives.