How to shelter your pension in uncertain times

Latest figures from the Association of British Insurers (ABI) show more people have been flexibly accessing their pensions since the first lockdown. They’ve reported a 56% increase in the number of people accessing their pension as a flexible income between April and September.

This apparent surge in pension withdrawals has set alarm bells ringing in some media reports.

If you have a defined contribution pension, flexibly accessing your pension means you can take as much or as little out as you want from age 55 (57 from 2028). Panicked over 55s who take large chunks out of their pension in response to the crisis could end up running out of money in retirement.

Contrary to media reports, our analysis suggests that people are in fact curtailing pension withdrawals, despite pandemic pressures.

This article isn’t personal advice. Pension and tax rules can change and any benefits will depend on your circumstances. If you’re over 50 and want to find out more about taking money from your pension, you could get guidance from the government’s free and impartial Pension Wise service. If you’re not sure what the best course of action is for your circumstances, please ask for financial advice.

Why might someone withdraw money from a pension because of Covid-19?

Drastic falls in the stock market might have been a shock to pension investors.

Defined contribution pensions tend to fluctuate in value anyway as they’re normally invested in the stock market. But, in large part due to the pandemic, it’s been estimated the typical pension fund lost around 15% of its value in the first quarter of 2020.

As a result, some people might have decided to ‘rescue’ funds from their pension and move them somewhere they thought as safer.

On top of this, recent ONS data shows a sharp decline in the number of over 50s still employed since the pandemic started. With thousands staring at the prospect of being forced into early retirement, many could find themselves tempted to dip into their pension earlier than planned.

Why hasty pension withdrawals could mean a poorer retirement

It’s inevitable that some people will need to turn to their pension in times of financial difficulty. But taking out too much, too soon could leave them deprived of pension funds in later life and relying on the state to get by.

The stock market situation complicates the problem. If investors sell when prices are low, the remaining investments will have to work even harder to recoup their losses. Over time, this could eat away at the value of the pension.

Flexibly accessing your pension has other consequences too.

Taking a large chunk out of your pension in one go could leave you with a hefty tax bill. Any withdrawals will be added to any taxable income from the same tax year, which could push you into a higher tax bracket. Remember tax rules do change.

How are pension withdrawals taxed?

Plus, once you’ve flexibly accessed a pension, you can’t pay more than £4,000 into money purchase pensions each tax year without incurring a tax charge. So, if you end up working again, you could lose out on a valuable opportunity to squirrel extra cash away. Pension rules can change over time, benefits depend on individual circumstances.

What does the data tell us?

Despite the doom and gloom messaging, recent HMRC figures paint a different picture.

Compared to 12 months earlier, the average value withdrawn from pensions has dropped sharply through the Covid-19 pandemic. And while there’s still an increase in the number of people withdrawing from pensions, it’s a lot lower than the year on year growth we’ve seen previously.

Pension withdrawals naturally spike in March anyway, as investors often want to use some of their remaining tax bands before the end of the tax year. With a year on year comparison, we can smooth out the seasonality effect and see a massive drop in the amount withdrawn in the second quarter of 2020.

While some might not have any other choice than to dip into their pension pot, what we’re actually seeing suggests some pretty good habits.

Lots of people are clearly showing restraint during troubling times and understand the implications of taking money from their pension in poor market conditions. We think this shows that many retirees are managing their money well throughout retirement and understand the risks associated with flexibly accessing pensions.

How to shelter your pension in uncertain times

For those already in drawdown, we think that only taking the natural yield is a sensible approach. This means taking only the income and dividends paid from your investments, so you’re not eating into the value of your pension.

Be aware though, relying on the natural yield might not always be possible, especially in tough times or for large expenses. Which is why we suggest holding around 1-3 years’ worth of expenses as easily accessible cash in retirement. Having a decent emergency fund means you’ll have cash to supplement your income when markets are struggling. Then you’ll be able to replenish your cash fund when markets recover.