Finances: Think twice before raiding your pension
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Withdrawing funds from a pension, either too early or too rapidly, can have a seriously detrimental impact on your future financial security, says finance expert Peter Sharkey.
When the taxman raises an eyebrow and notes with impassive, almost casual, understatement that one form of consumer activity is “contrary to seasonal patterns”, people rightly sit up and pay attention.
Not because they’ve necessarily done anything wrong, but HMRC’s latest analysis of “flexible” pension withdrawals (and the language used to describe it) suggests the taxman’s raised eyebrow could rapidly become a frown were recent unexpected trends to continue.
HMRC recently published statistics detailing the size and scale of “flexible payment” withdrawals from pensions between July-September, comparing them with the previous quarter and to 2019.
The Revenue noted that compared with the same period last year, an additional 20,000 people withdrew funds from their pensions between July and September 2020, bumping the total number of withdrawals from 327,000 to 347,000.
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There was also a rise in the number of people withdrawing money compared to the first quarter of 2020 which, said HMRC, “is contrary to normal seasonal patterns”. Ordinarily, observed the taxman, “[pension] withdrawals typically peak 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 [the second quarter] which … may be attributable to the impact of the COVID-19 pandemic.”
Yet while more people were taking cash from their pension, it appears that the average level of withdrawals made between July-September (£6,700) was £500 lower compared with the £7,200 average in the first three months of 2019.
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Although withdrawing money from a pension fund appears a remarkably simple means of plugging an income shortfall, even if it’s a relatively temporary one, most finance professionals would caution against such a move, believing it should be a last resort
The pandemic’s impact “has caused many people to reassess their financial affairs,” says Henry Gaskin, chief investment officer at award-winning Chartered Financial Planners, SG Wealth Management. “We’ve seen a wide spread of financial outcomes so far this year, from people who have been able to save more (with their income unchanged and expenditure down), to others who have been extremely hard hit through disruption of their work and/or family affairs.”
Mr Gaskin notes that HMRC data suggests “that more people have been leaning on their pension funds to help smooth the disruption to their other income levels. Such withdrawals can help ease difficult times but are not without implications. Any withdrawals taken before retirement will reduce the level of pension benefits payable in retirement. Furthermore, there could be tax implications of dipping into pension funds. Using other savings to bridge short-term problems could be more tax-efficient.”
Mr Gaskin urges individuals to seek guidance and financial advice “on the implications of accessing their pension funds, to help them make the best decisions, both in the short and longer-term.”
There could be significant longer-term consequences of dipping into a pension earlier than planned, not least the likely loss of tax relief on future pension savings. Excessive withdrawals could result in a little-known tax rule called the ‘money purchase annual allowance’ (MPAA) coming into play. This effectively restricts the level of any future pension savings on which tax relief is granted to an annual maximum of £4,000.
Paul Sweeny, managing director of Sweeny Wealth Management Ltd, believes it is vital for people to assess the full implications of withdrawing money from their pension. “It is important for individuals to remember that their pension is primarily designed to provide them with an income throughout their retirement, which may last for two to three decades,” he says.
Mr Sweeny adds: “The potential long-term consequences of taking money from a pension, either too early or too hurriedly, can have a seriously detrimental effect on an individual’s financial security and wellbeing in retirement.
“And those who think the state pension is sufficient to provide a decent standard of living once they reach state pension age are in for a rude awakening. The state pension provides little more than a basic level of subsistence, which is only likely to reduce in real terms in the years ahead.”
As HMRC notes, this unseasonal pattern of pension withdrawals could be a statistical freak, a one-off and things will return to normal during the third quarter. However, as this odious pandemic eats further into our way of life and the economy continues to take a battering, do the HMRC’s figures offer additional evidence that people are beginning to struggle? Many have seen their monthly income decimated; returns on savings remain negligible; employment prospects appear increasingly bleak and the dark spectre of inflation hovers somewhere in the background. Given this collection of miserable evidence, this probably isn’t a great time to be raiding your pension.
Instead of raiding your pension, there are alternatives: downsizing or re-mortgaging are two options, although for many, retirement planning may involve equity release, but how much could you release from your home?
The figure is determined primarily by your age, health and your property’s value, which must be at least £70,000. These are the principle requirements, although alternative options exist based upon personal circumstances. You can get a very good idea of how much equity you can release by visiting the Moneymapp.com website and filling out the equity release calculator.
It’s worth noting that equity release isn’t a panacea. It’s not suitable for everyone and it may compromise your eligibility for means-tested state benefits.
As many readers have already discovered, there’s a wealth of information to be discovered at: https://www.moneymapp.com/equity-release . In addition, there are hundreds of blogs and articles dealing with the subject on the Moneymapp website, including Peter Sharkey’s weekly blog, rated among the UK’s very best. Read more at: https://www.moneymapp.com/blog
You may still email any queries or questions regarding equity release to: email@example.com
Please note that Moneymapp.com cannot advise readers on whether equity release is suitable for them. However, Moneymapp.com can introduce readers to professional advisers who will explain the process and its implications for your estate and entitlement to means-tested state benefits.
Post-pandemic plans (parties and holidays are high on the agenda)
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For more financial advice, check out Peter Sharkey’s regular blog, The Week In Numbers.