It is rarely worth cashing your pension in early.
It will likely mean a big tax bill and you could subsequently run out of money in your retirement.
An especially bad idea if you intend blowing it on high living – expensive holidays, fast cars and a colourful love life.
Just about excusable if you are up to your neck in credit card debt or the bailiffs are about to repossess your home.
Covid-19 has put all this into sharp focus.
Many people are on furlough – unsure whether their job will still exist. Others have already been made redundant and in financial trouble.
Aware that they can do what they want with their pension pot once they reach 55 – cash in some, or all, of it – it is perhaps the last hope of avoiding catastrophe. A well-trodden path unfortunately – partly why the total value of flexible withdrawals from pensions since flexibility changes in 2015 have exceeded £37 billion.
HM Revenue & Customs (HMRC) third quarter figures make mixed reading.
A total of £2.3 billion was taken out, a two per cent decrease year-on-year. However, that involved 347,000 individuals, a six per cent increase. The average amount withdrawn per individual was £6,700, down seven per cent.
HMRC stated: “The number of individuals making withdrawals typically peaks in April, May and June, the beginning of the tax year, before dropping in July, August and September. However, this year, withdrawals have increased in July, August and September. This change in behaviour may be attributable to the impact of the Covid-19 pandemic.”
The Association of British Insurers (ABI) has a slightly different take on behaviour.
Perhaps its starkest statistic is that between April and September the number of people withdrawing their entire pension in one lump sum increased by 94 per cent.
However, withdrawals of all types remain below 2019 levels.
Encouragingly, it added: “Many pension savers are still resisting the urge to raid their pension pots in the face of continued financial uncertainty.”
Because panic responses often come at a cost.
You can take 25 per cent tax-free, but the rest will be taxed as income. It will be added to any other earnings and could push you into a higher tax bracket – up to 45 per cent.
There are implications for benefits including child benefit, universal credit, pension credit and council tax reductions.
And you are breaking the compound interest cycle which is so vital to building up the sort of pension which can maintain your standard of living in old age.
Rob Yuille, head of long-term savings policy at the ABI, urges savers to step back from any rash decision.
- Consider how much money you will need each month to maintain your lifestyle. Do you want to have annual holidays? Do you still have a mortgage to pay off? What other sources of income do you have and do you need your pension to keep up with inflation? Could you consider working for longer?
- Think about costs later in your retirement. Care needs are not a subject we are comfortable thinking about but it is important to have conversations about it with your family, as well as powers of attorney, wills and inheritance.
- Consider your health and life expectancy. We often vastly underestimate this but evidence shows we are mostly living longer.
- Take a ‘midlife MOT’ from the Money and Pensions Service or your employer and make use of Pension Wise or a financial adviser.
Raiding your pension pot should be a last resort.
There are few benefits to withdrawing from your fund early – and a large number of drawbacks.