Five ways to beat the Covid-19 pensions withdrawal trap

Haphazard pension withdrawals can create unnecessary tax bills, lead to bad investment choices and in the worst cases mean losing out to scammers.

Retirees planning to raid their pensions to ease families’ financial pressure in the wake of coronavirus job and wages cuts risk losing huge chunks of their nest eggs, experts warn.

The economic fallout from the Covid-19 pandemic has tempted many consumers to dip into their pension pots to get cash to spend now on themselves or their loved ones.

But haphazard pension withdrawals can create unnecessary tax bills, lead to bad investment choices and in the worst case can mean losing everything to scammers.

Savers who take their pensions early also reduce their future retirement income, often for unwise reasons.

A PensionBee survey in July found a third of 55 to 70 year olds would withdraw their pension if its value fell, often the worst time to do so. Around 12% would access their pension out of pressure to do something with it.

Jonathan Watts-Lay, director at Wealth at Work, money tutors, says: “There is a lot at stake but with some careful planning you can make sure you make educated decisions on what is right for you. 

“If you are not sure, or need help with understanding your options, it is important that you do your research, and get regulated financial advice if needed.”

• Revealed: the reasons we don’t save into our pensions
• Is coronavirus forcing you to retire later? Tell your pension provider
• Which generation had it tougher? We share your views

Wealth at Work has says there are five ways savers can avoid bad pension choices amid the financial pressures of coronavirus.

1.    Beware pointless tax bills

Withdrawing all of your pension savings in one go will trigger a high rate of tax – and a bill up to 200 times bigger than if you had planned ahead. 

If the amounts withdrawn from a pension (in addition to any other income that year) are more than £50,000, higher tax bands will apply. Choosing to take smaller, regular amounts can keep savers within the basic rate tax band.

2.    Use other savings first

Savings grow in a pension tax-free, so it is worth considering taking from other taxable savings and investments instead. 

Taking money from your pension while you are still working also triggers the money purchase annual allowance, which limits how much you can put into your pension to £4,000 a year, making it difficult to rebuild your pension pot.  

3.    Plan for a long life

The Office for National Statistics has projected people aged 65 can expect to live on average a further 19.9 years for men and 22 years for women. So it makes sense to plan for a long retirement. 

Retiring at 55 and living to 85 means paying for a 30-year retirement, which will require a large pot or very modest expectations.

• Pension funds bounce back, but annuities suffer
• Find out more about interactive investor SIPP and pensions here

4.    Transferring out of a defined benefit or ‘final salary’ pension

Since pension freedoms were introduced in 2015 savers have taken £127 billion from final salary schemes in order to spend more flexibly.

Pension transfers are complex. Consumers need to consider if the transfer value offered represents good value when compared to giving up a guaranteed, often inflation-linked, income for life. 

Moving to a defined contribution scheme also comes with investment risks. Regulated financial advice must be sought to transfer a final salary pension worth £30,000 or more.

5. Don’t let the scammers win

Scams have been on the rise following the coronavirus outbreak. Action Fraud has reported that more than £11.3 million has been lost to coronavirus-related scams, with pensions and investments a major target.

Check the company you are planning to use is registered with the Financial Conduct Authority at https://register.fca.org.uk and its ScamSmart website includes a warning list of companies operating without authorisation or running scams www.fca.org.uk/scamsmart.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.