Coronavirus and retirement – why you shouldn't access your pension just because of coronavirus concerns

Research shows that 1 in 10 of over 55 year olds have either already accessed their pension or plan to access it earlier than expected because of the coronavirus outbreak.

But if you can afford to, we think you should try and avoid this wherever possible. Pensions are designed for your retirement which could last 30 years or more. By dipping into your pension now to cover short-term costs you could seriously impact your future standard of living in retirement.

Your pension should really be the last resort if you need money to cover temporary costs. And here's why.

This article isn't personal advice. If you're at all unsure please look for guidance from Pension Wise or take advice. Tax and pension rules can change and any benefits will depend on your circumstances.

1. You could end up with a sizeable tax bill

For the most part, pension income is taxable. If you have a personal pension, like the HL SIPP, you can usually take up to 25% of it tax-free. The remaining 75% is taxed as income and added to any other income you receive that tax year, and taxed at your highest marginal rate.

Typically the first £12,500 of taxable income falls within the standard tax-free personal allowance. For income above this amount, different tax bands and tax rates apply. Making large pension withdrawals could end up pushing you into a higher tax band – and land you with a hefty tax bill.

Remember pension and tax rules can change and any benefits depend on your individual circumstances.

So just because you can access your pension from age 55 (rising to 57 in 2028), doesn't mean it should be your first lifeline. If you've got other savings which are easy to access, they might be a better option for giving you short-term support during the pandemic.

What if I need to take money from my pension?

If you need to access your pension because you have no other safety net, you could consider moving some of your pension into drawdown to avoid paying tax unnecessarily.

By choosing drawdown and opting not to take an income, you won't pay tax straight away. You'll receive up to 25% of the amount you moved into drawdown as a tax-free lump sum first. The rest will remain invested until you decide otherwise. It's not until you take your first income payment that you'll pay tax. This is called partial drawdown which we explain more about later on.

Whereas if you decided to take a lump sum (UFPLS) payment from your pension 25% would normally be tax-free, and the rest would be taxed as income right away.

Before you make any decisions about taking money from your pension, check you're happy with the risks involved. You can find out more about each retirement option, including the risks and benefits in our guide.

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For more information about how pension withdrawals are taxed download our factsheet.

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2. You could drastically limit your future pension payments

The second you take a taxable income from a money purchase pension, such as the HL SIPP, you'll normally trigger what's known as the Money Purchase Annual Allowance (MPAA). This reduces how much can be paid into money purchase pensions without suffering a tax charge.

Taking a taxable income normally includes taking a lump sum pension payment or income from flexible drawdown. You won't trigger this limit if you only choose to take your tax-free cash.

Normally the maximum amount that can be contributed to pensions in total from all sources (for example you and your employer) each tax year is £40,000. But if you're restricted by the MPAA the amount you can contribute to money purchase pensions reduces to just £4,000. You also won't be able to carry forward any unused allowances from previous tax years to increase the MPAA.

This could affect you down the line if your plan was to access your pension now, and build it back up later on when things get back to normal. With a reduced money purchase pension allowance you could really struggle to build up a sizeable retirement pot again.

3. You could lose tax-free cash on future growth

Over the past few months, many people's pension values have taken a hit because of the recent market ups and downs. This means the amount of tax-free cash available might be less than it once was.

If your pension value has been affected, and you're looking to take any tax-free cash entitlement (normally up to 25%), you could be choosing to sell at lower prices to make that cash available. This is a risk as markets could settle at a higher point in future, meaning you'd have sacrificed a potentially higher future tax-free cash value for the convenience of making a withdrawal now. Of course this isn't guaranteed, markets, and the value of your pension, could fall further in future. If you can afford to, it might make sense to look to other savings first.

Partial drawdown

If you have no other option than to take money from your pension, you could think about taking your tax-free cash in stages. By only using a portion of your tax-free cash entitlement the remaining amount could still benefit from future growth if markets rise. Remember though, there are no guarantees.

One way to take your tax-free cash in stages, is through partial drawdown. This involves only moving a portion of your pension into drawdown at a time.

For example, if you had a pension pot worth £100,000, you could decide to only move £10,000 into drawdown and take up to £2,500 (25%) as tax-free cash lump sum. The rest of that portion (£7,500) is moved into a drawdown account until you decided to take a taxable income. The remaining £90,000 would be untouched and continue to have the potential for future growth – and a higher tax-free cash value.

To find out more about drawdown, download our guide.

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