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MPs urged to tweak 25% tax-free cash rules

MPs urged to tweak 25% tax-free cash rules

LCP has called on the government to allow pension savers to access their tax-free cash at their minimum pension age while leaving the remaining balance behind.

In its response to the Work and Pensions Committee’s inquiry on pension freedoms, LCP stated that such change would avoid losses to consumers who either take 100 per cent of their pension and put the balance in a cash amount, earning little or no interest, or take their 25 per cent and move the rest to a higher-cost and worse-performing drawdown product. 

LCP pointed out that the most common choice made by savers when accessing their pension pot for the first time was to take the whole amount out in cash. 

Figures from the Financial Conduct Authority show that between October 2019 and March 2020, 55 per cent of policies were cashed out in full, while 35 per cent went into drawdown and around 10 per cent of policies were used to buy an annuity. 

More than 174,000 pots were cashed out in full in this six-month period.

A large majority of people are not taking advice or guidance about what to do with their pension pots, especially at lower pot sizes, LCP stated.

Laura Myers, partner at LCP and chairwoman of the Pensions and Lifetime Savings Association’s defined contribution committee, said: “Many people who want to access their tax-free cash find it easiest to cash out in full, but then put the balance in a cash account, losing out on vital investment growth on the balance of their funds.

She added: “Even those who put the balance into drawdown risk moving into a higher-cost environment with lower returns and poorer governance.

“Changing the rules to allow people to access their tax-free cash and leave the rest in their pension fund could be the best of both worlds.”

In terms of what people do with the money, separate research from the FCA showed that just 6 per cent spent the whole pot in one go, and a further 19 per cent spent the largest part of their pension. 

About 14 per cent used the money mainly to pay off debts, 20 per cent invested it, but nearly 32 per cent put the money mainly into a current account, savings account or cash Isa.

The concern is that those who put the balance in a cash account are moving from a low-cost environment where their money is carefully managed for growth, such as a workplace pension run by a master trust, to a deposit account earning next to no return.  

If the money is accessed at age 55, unused balances can sit in such accounts for many years, missing out on years of investment growth.

In February, the Work and Pensions Committee launched the second stage of its pension freedoms inquiry, with a view to examine the options available to savers when they come to access their pensions.

Rolhat Zen-Aloush is a reporter at FTAdviser's sister publication Pensions Expert