Is the pandemic destroying your pension pot?

As we wait out yet another week of lockdown there seems no end to the grim reports surrounding the virus. 

Now we are being warned that the pandemic is behind a surge of people taking money from their pensions early and diving into long-term savings to cover today’s costs. 

In the last three months of 2020, 360,000 savers accessed their pension early, an increase of 10 per cent in the same period of 2019, HM Revenue & Customs (HMRC) has warned. Between them, they took out £2.4bn early, up from £2.2bn in the same three months the previous year.  

The rules around early withdrawals from long-term savings pots changed in April 2015 when those aged 55 or over (rising to 57 in 2028) were first allowed to access money early from their pension pots without the eye-watering penalties of the past.  Since then, the nation has removed a total of £42.4bn.  

However, the amounts of money being accessed has been falling. The average amount withdrawn in the last quarter of 2020 was £6,600, down slightly from £6,800 the year before. It’s the number of people dipping into longer-term finances that is now worrying experts.

But with the UK going through the worst financial recession on record, is it really a surprise that more people are taking money out of their pots to help cover the shortfall they are facing today?  

Does the fact people are being forced to borrow from their future funds mean that the financial help being doled out by the government isn’t sufficient enough or does it suggest that savers feel confident withdrawing this money now in the belief that things will return to normal, and when that happens they’ll be able to top up their retirement pots and recover any shortfalls?

Helen Morrissey, pension specialist at Royal London, says the impact of the pandemic cannot be ignored when analysing these results: “While the number of people accessing their pensions continues to rise the average amount being taken continues its downward trajectory.  

“While this may point to people taking a measured approach to taking their retirement income, we cannot discount the potential impact of Covid with more people having to access their pensions to either supplement their own income or help out family members who have been negatively affected.”

It’s also important to look at the long-term consequences and costs of accessing this money early.  

Morrissey calculates that if someone had a pot of £100,000, assuming an investment growth of 5 percentage points and that nothing further was added or taken out, it would be worth £152,606 by the time they reach 65. If they had taken 10 per cent out early, when they were 55, it would be worth £137,345 – a difference of £15,261.

Morrissey adds: “While it is tempting to dip into your pension either to cover a short-term income shortfall or to help out a family member, the figures show you could lose out significantly over the long term in terms of investment growth.  

“Our data shows that over ten years you could lose a lot more than the amount you took out and this should be factored into any decision-making. Wherever possible try to make use of other income sources such as ISAs before accessing your pension.”

Another important nuance in the rules around flexible pension withdrawals is the money purchase annual allowance (MPAA). It is a limit of £4,000 (originally £10,000 but reduced in April 2017) on the gross amount each year which can be put into a pension pot annually if someone has accessed the it early. This is compared to a limit of £40,000 for those who haven’t touched their pension pots.

Some experts have called for the limit to be scrapped, or at the very least increased, to allow savers to add more into their pension pots once they’re able to.

Andrew Tully, technical director at Canada Life, says: “Dipping into your pension in advance of your planned retirement has implications, for two simple reasons.  

“You will pay tax on any flexible withdrawal which will be paid at your marginal rate of income tax. If you plan to top up your pension from earnings in the future, HMRC will restrict the amount you can save to £4,000 a year, and this includes any employer contributions.

“Leaving your pension intact until you retire not only has tax advantages, but you also benefit from a larger savings pot at retirement. In the rush to raid pensions, we seem to have forgotten why we took out a pension in the first place: to pay an income through retirement.”

If the allowance were changed, it would give savers the chance to top up their pension pots when things recover, if they are able to. It would also help to stem the impending retirement crisis, and shorten the long-term financial consequences of the pandemic, which can only be a benefit to all of us.