Navigating the financial storm that COVID-19 has brought can be challenging, especially when making decisions about your future financial stability. With 1 in 10 Brits over 55 considering dipping into their pension early, let’s delve into the implications and how best to approach your financial safety net.
Understanding the Impact of COVID-19 on Finances
Why Are People Turning to Their Pensions?
The global pandemic, which led to the UK government implementing a nationwide lockdown on March 23, had significant financial consequences. With over one million citizens on furlough – essentially a state-supported salary scheme covering 80% of wages up to £2,500 – and others facing unemployment, financial strain has become a common issue. A survey conducted by Opinium, which took responses from 2,002 UK adults, revealed that a startling 11% were considering using their pension savings as a temporary solution.
The Potential Pitfalls
Tom Selby, a senior analyst at AJ Bell, provided insights into the repercussions of accessing private pensions early:
- Pension Tax Implications: Withdrawing early can lead to the Money Purchase Annual Allowance (MPAA) coming into play, reducing your annual pension saving allowance from £40,000 to a mere £4,000.
- Sustainability Concerns: For those planning on taking a regular income, the current volatility can mean that an early withdrawal could exhaust the funds faster than anticipated. For instance, a 20% drop in the value during the initial year of withdrawal could deplete funds within 18 years. Given the rising average lifespan, this might not sustain individuals who plan to live well into their 90s.
Decoding Pension Jargon: Crystallising and Tax-Free Cash
When considering accessing tax-free money from a pension, one might come across the term “crystallising”. This means either drawing down funds or buying an annuity. But a word of caution: crystallising the entire pension uses up all available tax-free cash. If the fund grows afterwards, you cannot take additional tax-free money.
Tom Selby highlights, “With the FTSE100 down over 20% since the start of the year, a large chunk of pensioners have seen their funds decrease in value. Withdrawing during a dip can significantly reduce available tax-free cash.”
However, there’s a silver lining. If you need tax-free cash immediately:
- Partial Crystallisation: This lets you access a part of the pension, leaving the remaining to grow over time.
- Ad-Hoc Lump Sum: This means taking an irregular lump sum, where 25% is tax-free, but the rest is taxable and might activate the MPAA.
Even if you’ve crystallised, there’s more good news! You can still make contributions and grow tax-free entitlements. For instance, with a £100,000 fund, accessing all tax-free cash at 55 but saving £3,000 annually could lead to a £47,000 fund by age 66.
Staying Financially Savvy During the Pandemic
Lastly, Selby urges pension savers not to forget the importance of continued investment and to make the most of the lockdown period by reviewing retirement plans.
Accessing tax-free cash doesn’t necessarily imply a change in your investments. However, given the unpredictable financial landscape, it’s an opportune time to re-evaluate retirement goals and adjust investment strategies accordingly.
Remember, while the idea of investing might seem daunting now, history shows that short-term market fluctuations often lead to long-term growth. So, while considering dipping into your pension, always look at the bigger picture and make informed decisions.