Don’t be tempted to withdraw from your pension early, warns expert as savings crisis engulfs North East
The Covid pandemic could be triggering a pensions crisis in the North East, warns a Newcastle-based pensions expert.
As the Northern Powerhouse regions, such as the North East, were among those hardest-hit by the pandemic, it has been estimated that one in 10 working adults across the country stopped or cut back on saving for retirement over the past 12 months.
But Mark Parkinson, Partner at MHA Tait Walker Wealth Management says some went even further and withdrew cash from their pension pots prematurely in order to make ends meet. He described it as a short-term fix that could do significant long-term damage.
“We are seeing two problems here: firstly, people have understandably stopped saving because money is tight. Secondly, and more seriously, they have taken funds from their pension pots to solve short-term money worries,” he said.
The Association of British Insurers compared the months of September and April 2020 and found that people withdrawing all their pensions in one lump sum increased by 94 per cent.
The body also observed a 55 per cent increase in those only taking tax-free lump sums.
He explains: “A squeeze on finances, redundancies and furlough have meant many things have been put on the back burner.
“The Government is desperate for people to start spending again to help revive the economy, but we would also urge people to consider saving as well.
“Most of all, we would strongly recommend people don’t dip into their pension pots prematurely. It can be really tempting to do so when you see your statement – or perhaps you have been approached by a company offering to help you unlock that cash – but you will potentially lose huge amounts of your savings to the tax man.
“If you are thinking of withdrawing from your pension pot early, we’d urge you only to do so if you are fully aware of the implications. The cash you have saved is tax-free while it remains in your pension pot, but it becomes taxable the second it’s withdrawn.
To help people in the North East understand the impact of making lump sum withdrawals, the experts outline a scenario of an individual aged 60, who is aiming to retire at 65, with their State Pension starting at age 67.
Their initial aim was to use the tax-free cash from their private pension to clear their mortgage at age 65. Then a combination of any leftover funds from the tax-free lump sum savings and income from the pension to bridge the two year gap between retiring and their State Pension starting.
Being on furlough initially during the pandemic, they receive 80% of their normal pay before being made redundant in late 2020, due to cutbacks at their employer to help cover mortgage repayments and a shortfall in every day spending, they decide to release the tax free lump sum.
There are now various problems that can arise in the future:
- They will no longer have the lump sum from the pension to clear the mortgage at age 65 and may need to sell and downsize to clear the mortgage.
- Unless a better salary can be secured, ongoing pension premiums will be stopped and so there will be 5 years less pension premiums having been paid and so the value of the pension will be greatly reduced overall.
- They are unlikely to be able to retire at 65 as planned and so will have to work for at least 2 more years whilst waiting for the State Pension to start
- With the pension fund being worth less due to the shortfall in the premiums, the amount available to draw an income from will be less, impacting their plans and standard of living in retirement.
- They may no longer be able to leave any remaining pension funds on death to their children and grandchildren, because living costs have depleted the pension fund.
Parkinson offers advice for people who have made a withdrawal from their pension.
“Despite the success of the vaccine rollout, and the fact there may be green shoots of recovery in the economy, and there is still uncertainty as a result of the coronavirus, it’s clear people are still feeling wary about putting their money into a pension. However, now is a good time to review funds and there are several ways to rebuild a pension fund.
“It’s important that people take a long-term view of their pension and any break in payments should be kept to a minimum to avoid building pensions savings gaps and resulting in a negative impact on retirement plans.”
Parkinson said employers could do more to help staff to better appreciate exactly how much they will need to save in order to recuperate losses.
“Auto-enrolment has worked well to help more people start to save for their future, but in many cases it’s unlikely to be enough. People generally over-estimate the extent of state support, and under-estimate how much of their own money they will need in order to live comfortably during retirement. We’d like to see more employers encourage staff to save even more if they can,” he added.
This was posted in Bdaily's Members' News section by Flora .
Enjoy the read? Get Bdaily delivered.
Sign up to receive our popular North East morning email for free.