By Kevin Hollister, Pensions Actuary and Founder of Guiide, Guiide DB
Everyone has the right to take any pension pot they have in one go. There should not be any restriction to this choice. It is their money after all.
For lots of people there may be no issue, but we suspect a significant amount of people are causing themselves some harm. Here is what employers, schemes and providers should be protecting them from.
Paying too much tax
Many people who take a pension pot all in one go will be working at the time. Whilst 25% of any pension pot is tax free, 75% is taxable. That means it gets added to any other taxable income in that tax year.
Currently people pay zero tax on total income up to £12,570. Then 20% on any more between £12,571 and £50,270, then 40% on any more above that.
Let's say someone earns £35,000 and has a £30,000 pension pot. Taking the £30,000 all in one go means 75% (£22,500) is taxable. That means total taxable income is now £57,500. They will now be taxed 40% on £7,230. A higher rate of tax that they didn’t need to pay..
Instead of taking the £30,000 pot in one go, they should be warned of the tax consequences and shown how taking it over, say, two or three tax years would remove this.
Losing benefits
Lots of part time and lower paid full time working people are eligible for means tested benefits. This is usually Universal Credit before State Pension Age.
After State Pension Age, if they receive a full State Pension they are unlikely to receive much in the way of means tested benefits.
Someone who is working and claiming Universal Credit to top up their income may wish to take a £10,000 pension pot in one go. If they then put it in a bank account, they will have £10,000 in savings.
Pension pots aren't counted as savings before State Pension Age, but bank accounts or ISA's are. Universal Credit reduces with more than £6,000 in savings and is zero with more than £16,000, so in the example above they will lose some benefits.
This does not apply if people plan to use it to pay off debt immediately. If so, these won’t be added to savings in the bank, so Universal Credit is unaffected. In addition, the person will have reduced what they needed to pay servicing these debts.
Schemes and providers need to help members understand there is no point, if claiming Universal Credit, to take a lump sum from pensions just to put it into savings if this will affect their benefit entitlements. It is much better to only take money when needed to pay off debts such as a mortgage, loans or credit card bills.
Not having enough to live on in retirement
The Pension and Lifetime Savings Association (PLSA) provides some helpful figures. The PLSA estimates that you currently need around £14,400 a year, after tax, for a minimum single retirement income.
You will need more if you retire in London, have to pay ongoing rent, or if you are still paying off your mortgage for a few more years. You may need a bit less if you are in a couple and your partner gets at least the full State Pension.
By taking a pension pot as a lump sum, does this leave someone with enough other things to provide the minimum needed from the State Pension Age?
This could include other pension and savings pots. It could also include any home equity someone has and can use. Finally, any other pension and non pension incomes, such as some part time work, could be used.
Schemes and providers should be highlighting this to members and providing a quick calculation to see if this is likely to be possible based on everything they have. If not then they should be helping retirees understand how to use their pension pots better to try and support this minimum income.
Schemes and providers need to do more to understand how many are causing themselves harm and help them?
This problem has been around for nearly a decade given the pension freedoms. Yet up to now there has been no real initiatives or support provided to address these issues.
Concerned about their retirees, a number of employers contacted us for help to address this. We developed an At Retirement Protection initiative which any scheme or provider can implement to protect members who initially request all of their pension pot in one lump sum.
We are pleased to now see this has led to one of the larger workplace providers launching a similar process later this year after we raised it as a concern for their employer clients.
We are always happy to help bring positive change in the market to protect retirees and hope many other schemes and providers follow suit.
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