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Top tips to avoid the pitfalls of early pension access.

Jonathan Watts-Lay, Director - WEALTH at work

Latest figures from HMRC have revealed that 360,000 people withdrew from their defined contribution pensions throughout October, November and December 2020 which is a 10% increase on the same period last year.

These latest figures from HMRC highlight that many more pension scheme members are accessing their pension than would have pre-Covid. Pressure on household income caused by the pandemic is making it very tempting for those over 55 to reach for their pension savings to supplement their income. Redundancies are also leading to many individuals deciding to retire early and therefore access their pension for perhaps the first time.

But this is only part of the picture as others have found that they have to delay their retirement plans in order to re-build their pension pots that have been adversely impacted by investment market fluctuations.

A poll by YouGov found that 13% of over 55s are planning to delay their retirement, whilst a Fidelity study suggests 38% of people will put back retirement by around two and a half years.

It is thought that redundancies are likely to continue and many will still be on furlough or reduced hours. Despite the vaccination programme, it will take time for the economy to recover. Further redundancies and reduced work and hours is only going to further increase the pressure on household income and potentially result in yet more members accessing pensions early. But few realise the implications involved.

Employers and Trustees play a key role in ensuring members make informed choices concerning their pensions but it can be difficult to know where to start. To help, Here are some key points for those considering early pension access.

Tax implications
There are a number of tax considerations to be aware of when withdrawing from defined contribution (DC) pensions. Firstly, up to 25% of a pension pot can be received as tax-free cash, however anything beyond this is potentially taxable at 20%, 40% or 45%.

Also, when someone draws money from their pension beyond their tax-free cash entitlement, in most cases a money purchase annual allowance is introduced. This means an annual limit of £4,000 will apply to all future pension contributions, instead of the usual £40,000.  If contributions beyond this limit are made, a tax charge will be due.  This could be significant for those who are not yet retiring and are continuing working and contributing into their workplace pension scheme.

For many, other savings and investments may be a better source of short-term cash than pensions as it can help to avoid unnecessary tax being paid and allows the pension to grow in a tax-free environment.

Making retirement savings last
Most people live longer than they expect to, and so members may underestimate how long they think their savings need to last. For example, The Institute for Fiscal Studies found that those in their 50s and 60s underestimate their chances of survival to age 75 by around 20%, and to 85 by around 5% to 10%. Before accessing their pensions, members need to consider if they will have enough money to last throughout retirement.

Pension scams
A report by Action Fraud found that pension scams had become one of the most common types of fraud to occur last year and that £30.8m has been lost to them over the past three years. In addition, The Pensions Regulator (TPR) revealed it was investigating over £54m worth of lost pension savings, in cases affecting 18,000 savers. However, the FCA warned that this number is likely to be much higher.

TPRhas advised Trustees to urge members ‘not to rush decisions and provide them with clear, relevant and timely information’ so they can make informed decisions’. They also instruct Trustees to follow the Pension Scams Industry Group code of good practice, based on three key principles including: raising awareness of pension scams for members and beneficiaries; having robust processes for assessing whether a scheme may be operating as part of a scam; and being aware of the known current scam strategies.

DB pension transfers
XPS Pension Group suggests some schemes are seeing an increase in defined benefit (DB) transfer requests in the wake of Covid-19. However, LCP data suggests the trend in actual transfers is towards a smaller number of higher value transfers, with the average hitting £556,000 in the three months to June 2020. It may be that going forward the 3 biggest factors in members initiating a transfer request are; transfer value, the specifics of the scheme including strength of the sponsor (whether perceived or real), and lastly wanting to access cash due to financial constraints bought on by the pandemic.

Ensuring access to appropriate advice is key especially given that XPS Pension Group highlighted that 64% of transfers showed at least one sign of being a potential scam in November. Pricing is also key as contingent pricing was banned on the 1st October 2020, and so DB transfer advice will need to be paid for irrespective of the outcome. This means clear charging structures are crucial – the individual needs to be clear what they will pay even if the transfer does not progress. Many Trustees now facilitate access to reputable advisory firms having gone through a due diligence exercise to address these issues.

What can employers and Trustees do to help?
Many leading employers and Trustees are now putting robust processes in place to ensure that appropriate support is available for their pension scheme members. This includes providing access to financial education and guidance, as it can help members to understand their options, and the generic risks and pitfalls of certain actions. It can also help them to decide if they would like further support such as regulated financial advice, although this of course is a requirement for anyone looking to transfer a DB scheme over the value of £30,000.

Robust processes are required to help. When done correctly, facilitating access to regulated advice carries little risk. Due diligence should cover areas such as; qualifications of advisers, regulatory record of the firm, compliance process e.g. compliance checks of 100% of cases, pricing structure, and experience of working with employers and Trustees. Ultimately, empowering members by providing them with access to appropriate support should lead to better outcomes for all.

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