Raiding Pension Pots Could Be Costly

Desperate savers are raiding their pension pots to plug holes in their finances caused by the pandemic.

But calculations today reveal that pulling out your tax-free lump sum will cost you dearly in retirement.

Pension savings are locked up until you reach 55 when you can get your hands on every penny – or a 25 per cent tax-free lump sum.

The pandemic and deepening recession has caused much financial hardship, pushing many to dip into their pension funds early.

The latest figures show a rise in the number of people doing just that over the past three months.

HMRC data shows a 2 per cent rise between July and September compared with the second quarter of 2020 and a 6 per cent increase compared with the same time last year.

Yet there are now fears many more could follow after a third lockdown.

Experts warn that you should only to take money from your pension early as a last resort because of the damage it does to the value of your fund when you come to retire.

Starting to take an income from your pension at age 55 rather than 65 means you lose out on some or all investment growth for ten years.

A pension pot worth £250,000 at the age of 55 could grow to £380,000 over another ten years, according to calculations by Aegon.

Using that £380,000 pot to buy an annuity at today’s rates would give you an annual income of nearly £18,000. By contrast, the £250,000 pot would buy an income of just £8,700 a year.

If the saver chose to take the 25 per cent lump sum from the £250,000 pot at the age of 55, this would reduce the pot by £62,500.

But it would also cut the value of their final retirement pot to £284,000. This would mean the retiree could get an annuity income of £13,000 a year, rather than £18,000.

Steven Cameron, pensions director at Aegon, says: ‘Those over 55 do have the option of starting to draw on their pension but this can cause lifelong damage to future income and for most it should be a last resort.’

Jon Gale, 55, from Manchester, decided to cash in his tax-free lump sum in August.

He says: ‘Everything is rather uncertain at the moment and if the Government starts tinkering with the pension rules, I didn’t want to lose out.

‘I have no plans to retire but I wanted to ensure I got my 25 per cent tax-free to pay off a loan and have a decent financial buffer.’

Jon, who works in financial services, took the lump sum from a self-invested personal pension (Sipp) with investment platform AJ Bell. The six-figure sum is a number of old and closed workplace schemes from previous jobs consolidated into one.

He has now placed the money into premium bonds and invested a smaller portion in a stocks and shares Isa.

He says: ‘I appreciate that this money will not have the same opportunity to grow as it would in my pension. But job security is a worry for all of us, and so easy-access cash provides an important safety net.

‘Once we get through this pandemic, I would like to consider my options and look to enhance my skill set and possibly take time out to travel. Life is short.’

Over-55s who have suffered a job loss recently – because of Covid or otherwise – may have resorted to using their pension as a replacement income until they can find more work.

Nearly four in ten over-55s are now more worried about job security, according to a study by Standard Life. A third said they would retire early if they were made redundant in the next 12 months.

The HMRC figures show that individual withdrawals in the last quarter were £500 lower per person compared with the value of withdrawals in the same period last year, at £6,700 per person.