Four in five pension savers are accessing their pot early and it’s costing them tens of thousands of pounds, a pension provider has warned.
New analysis from Scottish Widows shows that 78pc of people raided their pension before they reached 65, pocketing an average of £47,000 in cash – which experts say puts them at risk of running out of money later in retirement.
After examining more than 232,000 customer transactions from 2019 to 2023, the provider found that among those who dipped into their pension early, more than half (52pc) did so five years before their selected retirement age of 65, costing them an average of nearly £14,000 in investment growth.
Another 21pc withdrew their money nine to 10 years early, missing out on almost £25,000.
The way in which a lump sum is taken can also make it much more difficult to restore a pot to its previous level.
Since the Conservatives passed pension freedoms legislation in 2015, it’s been possible to take a lump sum of anything up to the full amount of any pot after reaching the normal minimum pension age, with 25pc tax-free, and income tax payable on the other 75pc.
Taking your entire pension as a lump sum, or starting to take lump sums not only lands you with a tax bill, but will also trigger the Money Purchase Annual Allowance (MPAA), unless the pot is both below £10,000 and taken in full.
Once this happens, the annual amount you can contribute across all of your pensions from then on is immediately reduced to just £10,000 before tax charges apply. It also removes the right to carry over previous years’ allowances, hugely restricting your ability to replenish what you took out.
Andrew Tully, of Nucleus Financial, said: “The effects of the cost of living crisis will unfortunately be felt for years to come, so it’s no surprise to see greater numbers of people making withdrawals from pensions. But making your money last in retirement can be a significant challenge.
“There’s also a risk that many people won’t know about. As they continue or resume their working lives after making a taxable withdrawal from their pension, they and their employer may well want to keep paying into a workplace pension. But if they’ve triggered the MPAA, this will mean they’re hit with an unexpected tax charge that makes it much harder to rejuvenate their retirement savings.”
Data from the FCA shows that over half a million of those aged between 55 and 64 did just this when accessing money from a pension pot for the first time between 2019 and 2023.
Around 105,000 savers took a partial, taxable lump sum, while almost 400,000 took pots of more than £10,000 in full. Both of these moves would trigger the MPAA.
Taking a tax-free cash lump sum usually avoids the issue of the MPAA. Although you’ll still miss out on growth it would have earned had it remained invested, the rest of your pension will hopefully keep growing until you need to access it.
In this case, you’ll also remain entitled to tax relief on future pension contributions up to £60,000 or your annual salary, whichever is lower, and unused allowances can be carried over from the previous three years.
Graeme Bold, of Scottish Widows, said: “While early withdrawals are often an unavoidable necessity, draining a pension pot too soon can carry risks which both providers and retirees should be taking steps to guard against where possible.
“If retirement funds aren’t carefully mapped out against living costs, with expenses such as care factored in, some retirees will need to change their lifestyle, or run the very real risk of running out of money completely.”
Henrietta Grimston, of wealth manager Evelyn Partners said: “There can be numerous reasons for accessing a pension early. Some will be personal, such as supporting income needs or paying off debts. For others it could be to support the wider family, such as helping children on the property ladder or establishing a trust for the education of grandchildren.
“What we do know is people tend to underestimate life expectancy, and without proper planning may have underestimated their expenses in retirement. In this case, there is a real risk of running out of funds early.”
Last week, TV presenter Kate Garraway revealed she’d accessed her pension early to cope with “belated bills” from her late husband Derek’s illness. However, she only took a tax-free lump sum, meaning her ability to rebuild her pot is not restricted.
Mr Tully said: “The key is to take financial advice or speak to Pension Wise before you take money out of your pension, so you can work out the best option for your circumstances.”
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