An article in FT Adviser outlines a trend of increasing withdrawals from small defined contribution pension pots, with over £3bn being withdrawn under the UK’s small pot lump sum rules. This is based on data released by HM Revenue & Customs (HMRC) following a Freedom of Information request by the Just Group.
A “defined contribution” pension is one in which you, and often your employer, contribute a certain amount into your pension pot throughout your working life. The money you receive at retirement is dependent on the total amount contributed and how well that money was invested.
The small pot lump sum rules apply to those savers over the age of 55 who have smaller pension pots. As long as the total value of their pension does not exceed £30,000, or they have up to three pots each worth no more than £10,000, they can withdraw all of it as cash. However, such a withdrawal could be subject to tax.
Official statistics suggest that more than 4,200 people emptied their small pension pots each week in 2018/19. From the time the pension freedom was introduced in April 2015 to June 2019, £3.35bn was withdrawn by 785,000 people, averaging about £4,274 per person.
It’s important to note that these withdrawals under the small pot rules are not considered flexible payments, so they were excluded from the official figures published by the HMRC, which showed that £2.4bn was withdrawn flexibly in Q3 from individual pensions, with a total of £30bn taken since 2015.
Stephen Lowe from Just Group highlighted that this is the first time the scale of withdrawals from small pension pots has been revealed by HMRC. He said that for every two people taking a flexible payment, one person is cashing in a small pot, and for every £10 withdrawn in flexible payments, a further £1 is taken by emptying small pots.
Lowe’s comments indicate a concern that many people in the UK are ‘under-pensioned’, meaning they lack sufficient savings to maintain their desired lifestyle upon retirement. Withdrawing pension money early can exacerbate this issue, potentially making life harder in later years.
However, if individuals do want to withdraw all their savings from a small pension pot, using the small pot withdrawal method is considered the best way to do it. This is because small pot payments don’t trigger the complex money purchase annual allowance (MPAA) limits, which can restrict future pension saving to £4,000 a year.
The MPAA was introduced in 2015 alongside the pension freedoms. It’s the amount a person who has already begun drawing on their pension can pay back into their retirement pot in a given year without incurring a tax charge. The allowance was cut from £10,000 to £4,000 in April 2017.
Lowe urged people to think carefully before cashing in their pension pots, stressing that it may be tempting to have cash in hand, but small pots are often seen as insignificant, leading people to make decisions without professional advice. He also suggested that while flexible access to pensions may benefit some people, it could be detrimental for others who take out too much too soon, or too little too late. At present, the full implications of these trends are unclear, as we only have fragments of data, not a complete picture.