Savers taking advantage of pension freedoms to cash out before their retirement have suffered £2bn in lost returns, spurring calls for better financial education, according to analysis by LCP.
LCP cited figures released by the Financial Conduct Authority showing just over 1.7m people withdrew their full pension pot in cash between April 2015 and March 2020.
The FCA’s Retirement Outcomes Review following the introduction of pension freedoms showed 32 per cent of savers put the majority of their money into an Isa, savings or current account to either draw down or keep as a safety net.
LCP claims the majority of these would have been cash accounts, rather than stocks and shares Isas, a conclusion drawn because the FCA identifies as a separate category those who invested the largest share of their money in “capital growth”.
That category accounts for 20 per cent of the pots withdrawn.
An estimated 555,000 people took money from their pension and put it into a cash account or similar arrangement.
The problem arises because, though interest rates payable on cash accounts vary, many savers will currently be earning interest of 0.5 per cent or less on money placed in a cash account.
Had that money been left in a pension invested in a mix of stocks and bonds, it would have yielded an expected return of 4.4 per cent based on official assumptions, meaning savers placing their money in cash accounts are incurring a loss in returns of 3.9 per cent a year.
Aside from that, the fact that headline inflation is currently at 2.1 per cent means that savers are facing real losses of 1.6 per cent a year.
The FCA’s figures showed more than three-quarters of full encashments were taken by those aged between 55 and 64.
For simplicity, LCP assumed the typical withdrawal was at age 59 and that the money stayed in cash until the saver reaches the state pension age, 67, whereupon it is drawn in full.
Based on these assumptions, the consultancy estimated the 555,000 people suffered losses averaging £3,500 each, or a collective loss of £2bn.
‘Decouple’ tax-free cash from pension
LCP argued more must be done to alert consumers who are leaving the bulk of their withdrawn pension in cash accounts to the fact that they are suffering negative real returns.
It also reiterated its calls that savers who want to access cash from their pension should be allowed to withdraw 25 per cent of it tax-free while leaving the rest of it behind.
Though savers can put the remaining 75 per cent into a drawdown account, LCP argued this process was complex and could incur additional charges.
As a result, many savers take “the line of least resistance”, withdrawing the full amount in cash despite having no plans for the 75 per cent that is not tax-free, it said.
LCP partner Sir Steve Webb said: “For those who have already used their freedom to take their pension pot in full, more needs to be done to alert them to the real losses they will suffer if they simply park their savings in a cash account. And we need to ‘decouple’ the act of accessing tax-free cash from accessing the rest of your pension.