The dangers of drawing too much, too soon

Opinion on the level of this is split across the industry, with some statistics suggesting this to be the case, and others saying not necessarily so – a point this feature will discuss further on.

But if even a few people have been dipping more deeply into their pensions – quite understandably – given the financial concerns Covid has caused, are these people risking poorer financial futures? 

For Alan Chan, director at IFS Wealth & Pensions, there is a vital message to give to people who are considering taking just a little bit more from their pension pots now than they had originally planned to do.

He says: "The most important thing is for the client to know where they stand financially and the consequences of their actions, or indeed inaction, today.

"Most people who have taken money from their pension pots will know that they will have less to spend in the future as a result, and that may be OK with some."

Taking too much money out of a pension fund too quickly can create poorer financial futures for retired people. -- David Stevens

Recent research from life and pensions provider LV indicated that redundancies, wage cuts and a rethinking of priorities due to the pandemic has prompted about 150,000 people aged 55-65 to take early retirement, which suggests people could be facing a harder financial future.

According to David Stevens, savings and retirement proposition director for LV, taking too much money out of a pension fund too quickly can cause serious problems for people later in retirement – not just in terms of tax but also in terms of the pot's ability to continue growing after a sharp drawdown in the early years. 

This is known as the sequencing risk; a risk advisers attempt to counteract by spending time with clients working out what is the most appropriate and sustainable withdrawal rate for an individual to make sure the money lasts as long as possible.

He explains: "Taking too much money out of a pension fund too quickly can create poorer financial futures for retired people: they may incur unnecessary tax bills and risk running out of money in retirement. 

"For example, a £200,000 pension will last 11 years if you withdraw £21,000 a year and the fund grows at 1 per cent, and 26 years if you withdraw £9,000 a year."

Worrying behaviour

Behaviour in the months after the pandemic suggests people have indeed been taking a little more out of their pension pots than they had anticipated pre-pandemic. 

Figures from the Office for National Statistics and HM Revenue & Customs reveals that less was paid into defined contribution schemes after the first lockdown in March 2020, and more was drawn down in the last quarter of the year.

HMRC figures in January revealed:

• Throughout October, November and December 2020, £2.4bn was withdrawn from pensions flexibly.
• This represents a 6 per cent increase year-on-year from £2.2bn withdrawn throughout the same months in 2019.
• This comprised 360,000 individuals withdrawing from their pensions throughout October, November and December 2020 – a 10 per cent increase from 327,000 during the same months of 2019.
• The total value of flexible withdrawals from pensions since flexibility changes in 2015 has exceeded £42bn.

Stevens also notes there was a 4 per cent increase in the number of individuals withdrawing compared to the previous three months.

Sophia Dimitriadis, research fellow at the International Longevity Centre UK, says: "It’s very concerning that people are taking more out of their pension – especially if these are rash decisions borne out of panic."

She points to the fact that, since the market turmoil of 2020, the value of many pension funds has recently started recovering.

"This means there is a significant risk that many people may have lost out from taking out money from their pension," she says, adding: "We also know that many people have been saving less for retirement or have had to chip at their retirement savings as a result of the pandemic’s impact on their ability to work.

"It will be especially important for these groups to save more and not less for retirement, when they are able to, to counteract this drop in saving."

Alternative statistics

But there is another way of looking at the statistics – panning out to the past six years, the rate of drawdown has been steadily rising post-pension freedoms. 

This could indicate not a pandemic-induced panic but merely a slight escalation of an already established trend. 

In fact, the Association of British Insurers says one should not be misled by the HMRC figures, taken in isolation. 

Rob Yuille, head of long-term savings at the ABI, states: "It is not true that people were taking more out of their pension pots during 2020. 

"Figures from the ABI show that while the number of people accessing their pension as a flexible income increased by 56 per cent between April and September 2020, withdrawals of all types remained below 2019 levels for that period."

So while it is true that an increasing number of pension savers started to withdraw funds, this only came "after many pressed pause at the start of the pandemic".

Comparing data when restrictions were eased in September to April when the country was in full lockdown, there is a sense of caution expressed by pensioners:

• The number of people taking only a tax-free lump sum has increased by 55 per cent.
• The number of people withdrawing all of their pension in one lump sum increased by 94 per cent. This increased by 51 per cent during the same period in 2019. 
• The number of people buying a guaranteed income for life (annuity) increased by 41 per cent.

According to Yuille: "The increase in withdrawals is due to a combination of factors, including some people returning to drawdown after pausing earlier in the year due to stock market volatility and some people needing the money after a change in circumstances. "

This is also the view of Tom Selby, senior analyst for AJ Bell, who comments: "It is not clear from the available data that people have taken more out of their pensions in 2020 than in previous years.

"While the aggregate flexible withdrawals figure for [the whole of ] 2020 of £9.44bn is marginally higher than 2019 (£9.41bn), this figure has risen every year since April 2015.

“In fact, the increase from 2019 to 2020 was smaller than any previous calendar year since the pension freedoms were introduced, in part because savers cut back on withdrawals in Q2 in response to falling stock markets."

Furthermore, the average per person withdrawal in Q4 (£6,583) is the lowest since April 2015, when pension freedoms came into play.

Some clients, once they are in a better financial position, will want to know what actions they can take to steer their financial plan back on track. -- Alan Chan

Robert Cochran, retirement expert at Scottish Widows, says even a small short-term increase is not something to worry about.

He comments: "While there has been a slight increase in the number of people taking money out of their pension during the pandemic, the average amount withdrawn per member is small and the total amount withdrawn is not growing worryingly.

"In fact, the amount withdrawn in the midst of the pandemic remains much lower than in the second quarter of 2019, where a record value of funds were encashed."

According to AJ Bell analysis, the reason total withdrawals increase every year is that more savers are taking a regular retirement income, which Selby says is "another positive sign", and suggests this pattern might continue for a long time.

However, he does acknowledge the dangers of people taking "significant" withdrawals from their DC pensions, and warns them to think "carefully" about the sustainability of those.

This is particularly pertinent for those people who are in the early stages of drawdown and took a severe hit as a result of the Covid sell-off last March and April.

Selby adds: "This is one of the reasons it is crucial to stay engaged in drawdown and regularly review both your assets and your withdrawal strategy.”

Getting back on track

There is nothing wrong with using the flexibility brought in by the 2015 pension freedoms regime.

Steven Cameron, public affairs director for Aegon, says the freedoms with DC pensions from age 55 can be "hugely helpful, allowing people to use their pensions to support themselves financially in very flexible ways".

However, he warns: "This does come with risks of taking too much out too soon and their pension pot not being adequate to provide them with an income throughout life.

"There is also a risk that people draw from their pension flexibly from age 55 to cover a short-term loss of employment but then rejoin the workforce and find they are unable to ‘catch up’ because the money purchase annual allowance restricts contributions from them and their employer to £4,000."

This is why Aegon would like to see the MPAA lifted to at least £10,000. In any case, he urges people who have drawn down more the past year or so to "seek professional advice". 

Investing your money wisely can pay dividends in the long run. Rob Yuille

Cochran says that people accessing their pension sooner may not necessarily risk poorer financial futures, because it depends on a range of things: "It's a question of timing, what age they are at the time of accessing their cash, what other savings they will have when they retire, and when they plan to stop working.

"For many, it will be best to remain invested, while some may face more immediate financial priorities and so accessing their funds sooner rather than later could be best for their individual situation."

Some clients may have only wanted to dip into their pension pots temporarily for those "immediate" priorities; for example, some advisers have told FTAdviser of clients who have spent liberally on helping their children and grandchildren through the pandemic.

For example, one couple took a sum out to buy a car for their daughter, who is an NHS worker, so that she did not have to travel on public transport and put herself at even more risk. Hardly profligate spending, and again not a worrying sign of mass Lamborghini-buying.

In these and other cases, people may want to start putting money back into the pot where they can, and will need advice on how to do so.

Yuille says: "Investing your money wisely can pay dividends in the long run, so we urge people to continue and/or restart saving into their pension again whenever possible."

Like Cameron, Yuille wants the MPAA to be scrapped, although the ABI thinks this should be replaced with recycling rules, and urges people to seek professional advice.

The IFS's Chan comments: "Some clients, once they are in a better financial position, will want to know what actions they can take to steer their financial plan back on track."

He outlines the main ‘levers’ in their financial plan as the following:

• Pay more into their pensions or retirement vehicles.
• Delay retirement by some years.
• Reduce their income need in retirement.
• Review their pension funds to ensure they are performing to standard and/or increase the risk they are taking.

However, Chan strongly advises people exercise caution and get proper advice if they are considering pulling the fourth lever in this outline.

At any rate, it appears advised clients have been taking money sensibly, rather than indiscriminately, from their pots and alarm need not be sounded – at least, not yet.

simoney.kyriakou@ft.com