The Risks of Pension Unlocking
Unlocking your pension should never be seen as an easy way to raise cash, although it is possible to raise some money from most pensions, from the age of 55.
Unlocking your pension will almost certainly mean that you will have less income in retirement AND because of the reduced level of income, pension unlocking is usually only suitable for a very limited number of people and circumstances.
All other options should be investigated fully before you consider unlocking your pension.
Many people seek to unlock their pension because of financial pressures, but all other avenues should be explored too, such as:
- Talking to your creditors
- Consolidation loans/cheaper credit
- Debt Counselling
- Individual Voluntary Arrangement
- Raising other funds
All other avenues of raising funds or resolving the issues that require the funds should be explored before you unlock your pension, as it is not suitable for most people, because of the many disadvantages.
Pension Release - the dangers
- Your retirement income will be reduced by unlocking a pension early
- There may be penalties for releasing your pension early
- You could incur penalties for taking it early (e.g. market value reductions)
- You could lose guaranteed benefits
- You may lose a future guaranteed income
- Any income could be taxed
- There could be loss of benefits for your partner and/or children
- You may lose benefits in the event of ill health
- Taking benefits could mean that you can not claim some state benefits, either now or in the future
- There are costs incurred with unlocking a pension
- Pensions are usually safe from creditors in the event of bankruptcy - cash in the bank is not
Final Salary Schemes and the Risks of Pension Unlocking
Probably more than any other type of scheme, the greatest risks and biggest disadvantages, come from unlocking and releasing cash from a final salary scheme.
Final salary schemes provide an income in retirement that is linked to your length of service and earnings. It is the scheme's and your employer's responsibility to ensure that the pension scheme has sufficient funds to pay the pensions. If the scheme does not have sufficient funds then the employer must take steps to address this. The investment risk, inflation risk and risks about how long the pensions must be paid is not yours but your employer's responsibility. So provided your employer can fund the scheme, your pension should be secure.
Even if your employer becomes insolvent and the scheme can not afford to meet its liabilities then there is a "back up" scheme in place to protect you, this is called the Pension Protection Fund . The level of protection varies; if benefits are in payment then it would provide 100% of the income and for members not yet taking an income it would be 90% of the pension. There is also an upper limit and other limitations too, see the compensation limits of the Pension Protection Fund. This scheme is funded by a levy/charge against all such pensions and not funded by the Government.
Remember that final salary schemes can also provide benefits for dependants, such as a wife, partner or child and the benefits normally have some sort of inflation protection too. If you transfer your benefits out of these schemes, these benefits could be lost or reduced. Remember, even old final salary schemes are not "frozen" they are, in fact, deferred pensions and usually have some inflation proofing or other increases. They are not really "frozen" they will normally be increasing in one way or another and sometimes at a rate far above inflation.
So, even though it is possible to unlock a final salary scheme by transferring the fund away, you would be giving up some very valuable benefits which are backed by your (former) employer and the Pension Protection Fund. See cashing in a final salary scheme.
Taking benefits early direct from a final salary scheme (if possible) will usually mean significantly reduced benefits too, usually a smaller lump sum and/or smaller income.
The risks of unlocking a Personal Pension or Occupational Money Purchase Scheme
Unlike a final salary scheme, personal pensions and occupational money purchase schemes are pensions where your income in retirement will depend upon the size of the fund and annuity rates. The theory is that the larger the fund, and the older you are when you take the income, then the bigger the income you will receive.
So, the earlier you take these types of pensions, the lower the benefits, because generally, the fund would not have had as long to grow and annuity rates are lower at younger ages. The two examples below illustrate these points assuming an annuity is bought:
Mr Smith, age 55, with a fund value of £50,000, unlocks his pension. This would provide:
A tax-free lump sum of: £12,500
Income of: £1,708 p.a.
The fund after tax-free cash provides £45.55 for every £1,000.
Supposing Mr Smith did not unlock his pension, the £50,000 would have longer to grow and if we assume it grew to £100,000 then at age 65 it would provide.
A tax-free lump sum of : £25,000
Income of: £4,265 p.a.
The fund after tax-free cash provides £56.86 for every £1,000.
The examples above are based on actual annuity rates, as at 11th September 2012 and are based on a level annuity, with no inflation proofing and no benefits for his wife, with a ten year guarantee. (See the section on annuities if you want to know more).
The above examples show the downside to unlocking an Occupational Money Purchase pension or personal pension arrangement by buying an annuity. Buying an annuity is not the only option and it would also be possible to use an income drawdown contract. This could allow you to just take the tax-free lump sum and with the option of no income. This would leave the rest of the fund invested to buy an annuity at a later date. But there are downsides to this too, such as the extra costs, see flexi-access drawdown pages for more information.
There are other potential disadvantages in taking money purchase pensions early. Some schemes have guaranteed benefits, perhaps in terms of the fund value or its future growth. Sometimes, older contracts have guaranteed annuity rates, this was a promise by the company to give you a certain amount of income per £1,000 of benefit. e.g. a contract may have said that when you retired at age 65, it would promise to give you an income of £100 per £1,000 of pension fund. This is much higher than the current market level, but such a rate could only be available by keeping it with the existing provider, and such a rate may only be available at/or above certain ages. So these benefits might also be lost if you unlock a pension.
Taking any type of pension benefit early should not be entered into lightly, and you should ensure you have pursued all other possible options first.
Contact us online, or call 0800 011 2713 , without obligation to find out more about "unlocking" your pension, what it would mean for you and the risks for you.
Warning: Taking any of your pension benefits early is likely to reduce your income at retirement. Therefore, pension release is only suitable for a very limited number of people and circumstances and should not be seen as an easy option for raising cash. This is because a pension is designed to provide you with benefits when you retire. Always seek independent financial advice, which we offer.
If you can't find the information you're looking for on the website, or you want to know more or have a question, or just want to chat through some details about your pension then please feel free to contact us, without obligation. Either contact us online or call 0800 011 2713.