20th August 2015
People taking advantage of the new pension freedoms may be unwittingly setting themselves up for a financial shock claims new research.
The analysis from insurer Royal London found that of its customers who had decided to take advantage of the new pension freedoms, some 69% had chosen to take all of their pension pot as a cash lump sum. This means that, in most cases, 75% of the cash sum those customers received was subject to an income tax charge.
Some 16% of those surveyed said they intended to use the cash to clear their mortgage or other debts but the study also highlighted that 32% of these customers intended to withdraw their money in order to place it all in an alternative savings or investment vehicle. Of those questioned, 23% intended to leave their money in cash within a bank, building society or cash ISA account which may pay a lower rate of return than their pension.
Commenting on the findings Fiona Tait, pension specialist at Royal London said: “We are extremely concerned that the findings from the research may reflect a wider industry trend. The research indicates that around a third of people who are withdrawing cash do not appreciate that their options could include a switch to a similar investment fund within their existing pension plan without paying the tax charge for full encashment or switch to an alternative provider which allows partial encashment. Customers aged over 55 would still have access to their savings whenever they need it and withdrawing money over time is likely to be much more tax efficient. Now we have these findings, Royal London is looking to update the questions we ask in order to check future customers understanding of the implications.”
Royal London found that the average size of pension pot being accessed was £15,500 but the typical size of fund being fully en-cashed was slightly lower at £14,100. Based on these figures the likely initial tax charge would be £3,347. This is because a cash lump sum is likely to be subject to emergency tax on payment, although it is possible to reclaim any over-payment at a later date.
Based on the research findings, Royal London is calling on the City watchdog, the Financial Conduct Authority (FCA), to consider raising the prominence of this option in its future review of the rules and guidance. This would help a wider number of customers to understand the potential benefits of continuing to keep cash in a pension. It would also help to improve customer awareness of the consequences of cashing in their pension pot, particularly if they only wish to have the funds sitting on deposit.
Tait continued: “Royal London does want the pension freedoms to work, but not at the financial detriment of customers. Where customers are looking to pay off debts or spend the money on a vital purchase, the tax charge may well be a price worth paying. However, if the intention is for the cash to just stay in a savings account, consumers are potentially paying a tax charge for no additional financial benefit. Having extra focus in the Retirement Risk Warnings framework would help to ensure that customers appreciate all the options they have within their existing pension. This is particularly important for those customers who are not willing or able to access financial advice.”