Can you be sure of a comfortable retirement after the pandemic?
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Financial security in retirement can never be taken for granted. But for millions of workers who have seen their pension plans hit by the Covid-19 pandemic, the outlook has become a good deal more precarious.
Across the UK, hard-hit savers of all ages have been reviewing their pension arrangements, from whether to dip into their pensions earlier than expected or temporarily halting saving until the economic outlook improves.
For all generations, there is a risk that rash decisions taken to shore up your position in the current crisis will have a long-term impact, among them failing to factor in market downturns when taking withdrawals from a pension fund, or pausing contributions for short-term financial relief.
We are living longer than ever, with girls born today expected to live on average to the age of 91 and boys to 87, according to the Office for National Statistics. People are working longer and retirement ages have risen — but not everybody wants to work later in life and, in any case, employers do not necessarily wish to retain older people.
The pandemic has cast a long shadow over the economy — there is no guarantee of a rapid recovery, so future incomes may be lower than planned — reducing the opportunity to compensate later for money taken out now from pension funds.
FT Money tackles the key pensions issues facing savers during the pandemic.
I am 55 and considering taking my pension early to help through the crisis. What do I need to consider?
Since lockdown began in March, a rising number of over-55s have tapped into their pension pots. Recent figures from HM Revenue & Customs showed 347,000 people in this age group withdrew cash from their pensions over the three months to September — a 6 per cent increase on the same period last year. During the same period, a record 314,000 workers lost their jobs.
While it might be tempting to use a pension pot as a Covid-19 relief fund, experts advise retirement savers to think carefully before dipping into their pensions if other liquid assets are available, such as tax-friendly individual savings accounts (Isas).
“Assuming that your pensions and Isas are invested rather than in cash, and that your pensions are not defined benefit company schemes, a key point to consider is whether these have recovered fully from market falls,” says Christine Ross, client director at Handelsbanken Wealth Management.
Pros and cons: pension vs Isa withdrawals
You can withdraw money from an Isa tax free.
When you draw on your pension, you can take up to 25 per cent of your fund as a tax-free sum (subject to the lifetime allowance, currently £1.07m). Withdrawals above this level would be subject to income tax at your highest rate.
If your earnings in the current year have been low you may not have used your personal tax allowance fully, in which case it might be worth drawing taxable income from your pension — in excess of your tax-free cash — which could be offset by the personal allowance (£12,500 currently).
If you are working, and you plan to continue to make pension contributions and benefit from an employer contribution, drawing pension income now will invoke the Money Purchase Annual Allowance — the rule which restricts the amount you are able to pay into a pension in future to a maximum of £4,000 each year.
Pension funds are held outside your estate for inheritance tax purposes and can be inherited by your nominated beneficiaries. If IHT is a consideration, then the pension, at least from a tax perspective, should be the last port of call.
“Drawing on funds that are at a depressed value will have a greater impact on your savings in the longer term.”
Ms Ross adds that there also tax issues to consider, since both pensions and Isas offer tax-free investment growth (see box). “If possible, rely on cash savings to start with but do not fully exhaust these as you will always need some available liquid funds,” she says.
“Depending on personal circumstances it may be preferable to first draw funds from an Isa than from the pension,” said Ms Ross. “Pension funds fall outside an individual’s estate for inheritance tax purposes, whereas the value of the Isa would be included when valuing an estate and could be liable to IHT. It therefore makes sense to reduce the value of the Isa first.”
If you determine the pension is the best source of funds then you need to decide whether to take tax-free cash only (up to 25 per cent of the pot), based on your current tax position, but importantly on your future intentions regarding pension saving.
I need money for living costs. Should I pause payments into my pension scheme?
If you do not have sufficient cash to meet your living costs, then temporarily halting your monthly pension contributions makes sense. One in 10 workers have done so since the March lockdown, according to research by Canada Life. However, advisers say you should think carefully about taking this step, and should consider other actions, such as lowering contributions, first.
“If you are in a workplace pension scheme, stopping pension contributions will most likely also result in employer pension contributions ceasing, which is effectively a loss of benefit,” says Gary Smith, chartered financial planner at Tilney.
“Where affordability isn’t an issue and you can afford to make payments, then maintaining them does make sense, especially as you can take advantage of ‘pound-cost-averaging’ during this period of volatility,” said Mr Smith, referring to the strategy of making regular small payments to protect against sharp drops in the market. He advises savers to reduce contributions rather than stop them completely.
How will my fund be affected if I stop pension saving?Pausing your pension contributions might seem like a “no-brainer” during hard times, but it could be costly in the long term.
Hargreaves Lansdown, the investment manager, estimates that workers in the millennial age bracket, saving 6 per cent of salary into a pension with a matching employer pension contribution, could be tens of thousands of pounds worse off in retirement if they took a 12-month pension holiday.
Hargreaves assumed a 25-year-old and 35-year-old were saving for 46 years until the age of 67, with 5 per cent annual returns after charges.
A decision to stop saving for a year would leave the 25-year-old, earning £30,420 a year throughout their career, with a fund that would be £27,709 (4.3 per cent) smaller at retirement. The pot of the 35-year-old, earning £40,000 a year throughout their career, would be down £22,368 (2.7 per cent).
“Taking just a year out of saving can dismantle even the best laid retirement plans, with the youngest savers being particularly vulnerable as the money they pay into their pension today should benefit from many years of compounded investment returns,” says Nathan Long, senior analyst with Hargreaves Lansdown.
“Sticking with pension saving when the immediate future looks bleak may seem counterproductive, but the consequences of pressing pause on your pension will be to pay in more in future years or retire later, neither of which are particularly palatable.”
My pension fund took a knock this year. How can I rebuild it?
The pandemic has taken a heavy toll on stock market-based pension portfolios. The typical retirement fund lost around 15 per cent of value in March, when the virus hit, according to Moneyfacts, the financial information provider. While many funds may have since recovered these losses, those nearing retirement will face a dilemma over how to rebuild their funds if they are severely dented.
While many savers in their forties and fifties would have been insulated from the deepest falls of the stock market, due to diversifying into assets, such as bonds or cash, many funds will not be at pre-pandemic levels, leaving savers facing a shortfall in retirement.
Mr Smith of Tilney says savers in this age group might want to consider raising their exposure to equities in their pension portfolios.
“Very few retirees now purchase an annuity when they retire, with many preferring to take advantage of flexible retirement options, such as flexi-access drawdown,” said Mr Smith, the latter referring to pension accounts where investors can withdrawn as much or as little as they wish.
“With these types of retirement options, pension savers can continue to take a medium to long-term view with their investments, thus enabling risk to continue to be maintained within their pensions.”
Mr Smith says someone five years from their retirement date might want to consider retaining three years of expected income in cash within their pension and investing the remainder in more risky investments. It could be eight years before they needed to access the risk-based assets.
I have received a sizeable redundancy payout. Should I put this money into an Isa or my pension? I am in my forties.
If you need the money to meet bills, mortgages and other essential spending over the next six months to a year then it is probably best to keep the money in cash that you can access easily, says Ian Browne, retirement expert at Quilter, an independent financial adviser.
But if you have adequate savings to keep you going until you find a new job, you could put the redundancy payout to work.
“An Isa will protect it from tax on growth and the current Isa allowance means you could potentially invest it all this year,” adds Mr Browne.
“If you really want to maximise the cash, putting it into a pension means it will attract tax relief. That’s a 20 per cent boost straight away, and through your tax return you can claim additional relief depending on your marginal income tax rate. This will depend on your earnings to date and salary when you get a new job. You should consider speaking to a financial adviser about this.”
What happens to my pension if my employer goes bust?
If you are a member of a defined contribution pension scheme and your employer closes, the money you have already built up in your pot, including contributions made by your employer, will remain yours.
If you have a defined benefit pension, you will be covered by the Pension Protection Fund (PPF), which continues to pay your retirement income if your employer becomes insolvent, subject to a cap, which is currently £41,400 at age 65. Pension benefits above this threshold will not be paid.
This cap was declared unlawful by the High Court this year but remains in place until the outcome of an appeal by the government against the ruling. Inflation increases on PPF compensation might not be as generous as your workplace scheme.
In spite of these reductions, PPF compensation is still valuable. Most private sector schemes allow members to transfer their benefits to another private pension, which will give you more flexible access to your cash. However, there are pros and cons to giving up a secure retirement income for a cash lump sum. Where the transfer value is more than £30,000, it is a regulatory requirement for you to seek advice in relation to the transfer of the benefits.
This article has been amended to reflect the fact that the PPF compensation scheme is currently capped.
The older worker’s dilemma
Yvonne Bamgboye, 58, had hopes of retiring within the next few years, and living off the pension savings she had diligently built over four decades of working life. But her ambitions were blown off course by the pandemic, which hit her earning capacity.
“I had been made redundant in 2019 and had been hopeful of quickly finding another job in my specialist field,” said Ms Bamgboye who has held senior management positions in the tech sector.
“But Covid-19 put a halt to my job search plans. It has been incredibly difficult to try and secure a job. I feel my age hasn’t helped.”
Without regular income from a job, Ms Bamgboye, who lives in Hertfordshire, has reluctantly taken the decision to dip into her pensions to cushion her financially until she finds another position.
“I did not want to do this as it means I will be less comfortable when I eventually retire,” she said.
“I had also hoped to use some of my pension cash to help my children, such as for a house deposit, but I just don’t have this cash any more.”
The younger worker’s dilemma
Like many people her age, 28-year-old Sarah Bennett, who lives in Stockport, had not spent too much time thinking about retirement.
“It wasn’t at the forefront of my mind,” said Ms Bennett, a director of Hollands Country Clothing, ta family online retailing business. “I am paying into a pension but I hadn’t really thought whether it was enough.”
However, her attitude towards pension planning changed sharply this year when the coronavirus pandemic gave her a “little kick up the backside” to review her finances.
“I’d seen my friends being put on furlough, or being made redundant, and the negative impact that was having on them,” she said,
“Some of them are struggling to find another job. Others have had to go from having a very decent income to minimum wage jobs. Like me, pensions weren’t really on their minds.”
Closer to home, Ms Bennett was also seeing how her mother’s retirement decisions had affected her. “My mum has recently retired and was feeling the pinch living off her pension,” she says.
“She didn’t start to think about her pension until her late thirties or early forties. She used to put articles about pensions in front of me as a teenager and tell me to start saving as early as I can, as much as I can. But when you are a teenager you don’t listen to that advice.”
Ms Bennett was prompted to review her own financial position, including her spending. “I realised I was wasting a lot of money before. This year I started to take on board the advice people had been giving me.”
She was in the fortunate position that the family business was doing well as more people took to exercising outdoors during lockdown.
“I decided that while I can, I should really pay more money into my pension,” she says.
She channelled some of the money she saved by not going out into her retirement plans, raising her pension contributions twice — from £105 to £150 then £180 a month — since the pandemic began.
“My target over the next 12 months is to keep increasing my contributions while I can. This whole experience has been an eye-opener and positive for my pension plans,” she says.
Romi Savova, chief executive of PensionBee, Ms Bennett’s pension provider, says: “We would encourage young savers who find themselves with a stable disposable income to continue saving through the pandemic, as periods of economic uncertainty have proven to be a great opportunity for investors of all sizes to benefit.
“If they can afford to make additional contributions to their pensions now, ahead of an eventual market recovery, they could potentially make up for years of savings neglect and put themselves in a strong position for retirement.”