Why you could lose the freedom to cash in your pension

The new pension rules, introduced in April 2015, allow people over the age of 55 to cash in their entire pension pots for the first time in history. This revolutionary reform has been described as a ‘welcome once-in-a-lifetime change’, however a new report has suggested the freedom to cash in a UK pension should be partially reversed.     

Global consultancy firm Mercer has ranked the performance of 25 national pension systems, and believes its findings show that the UK pension structure is in need of a makeover. Each country’s system was assessed on its sustainability, integrity and adequacy. The UK system ranks ninth place, falling behind Australia, Denmark and the Netherlands, as shown in the chart below.

Questioning the freedom to cash in your pension 

The UK’s new pension rules do not require at least 50% of the accumulated retirement benefits to be taken as an income stream, which, according to Mercer, affects the adequacy of the UK system.

It was once a requirement for people to use part of their pension to produce an income in retirement, but current rules allow savers access to their entire pension to spend however they wish. This prompted fears that the flexibility would encourage people to spend frivolously, but that has not been the case and most people have been prudent with their pensions.

Of 60,000 pots that have been cashed in, around half were worth less than £10,000. If converted to an annuity today this could provide an annual income of £359, or just £256 if you were to withdraw your tax-free cash*. Some providers require a minimum pension value of £20,000 to purchase an annuity, which can make it difficult to secure an income with a smaller pension pot.   

These figures may not spark fears over cashing in, although they could signal a lack of UK retirement savings if these are the only provisions people had. The population is ageing so there will be more years spent in retirement, which means more later life income is needed.

The government introduced the ability to cash in an entire fund to give pension savers more freedom over their finances and retirement plans. However, there are risks associated with cashing in: 

  • You could be giving up benefits that are payable on retirement such as additional death benefits or a bonus payment
  • You could face a very large tax bill depending on how much you withdraw
  • You could miss out on tax-free growth and tax relief on contributions
  • You could also miss out on employer contributions into your workplace scheme
  • You might be left with little to no income in retirement

Pension changes overload

An issue with Mercer’s recommendation to reverse the changes is that pensions have already undergone several changes recently, and constant reform can risk making them confusing and unappealing.

The most recent changes took effect just six months ago and already there have been discussions regarding pensions becoming more like ISAs, which signal that there could be further pension changes on the horizon.  

Whether or not the ability to cash in your entire fund will be reconsidered following Mercer’s report remains to be seen.

Do you think that the freedom to cash in your pension should be restricted? Let us know with a comment below.

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Important information

Quotes based on a female of 65 years of age, who is a non-smoker and in good health, on a single life basis payable monthly in advance, with a 3% per annum fixed escalation, a guarantee period of 5 years and including an adviser charge of 2%

Melbourne Mercer Global Pension Index 2015

Tax treatment depends on your individual circumstances and may be subject to change in the future

The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article. For our latest information and news, please see our articles section: https://www.portafina.co.uk/whats-new

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