Early pensions access: how to do it

Four options for allowing early pension access are set out in the Treasury’s consultation paper on early access to pension savings. In my last post, I looked at the non-starters. This time round, the clear winner for defined contribution schemes:

“Early access to the 25 per cent tax-free lump sum: currently available from age 55”

This option presents new financial planning opportunities – perhaps using the lump sum earlier to pay off mortgage or personal debt sooner, for example – which may ultimately lead to better retirement provision. Currently, the 25% tax-free lump sum is frequently used for things other than directly providing retirement income; some are frivolous, some form part of good financial planning. In any event, £3 in every £4 in the pension fund is still there for providing a retirement income. That provides a good back-stop for those wanting early access to try to escape hardship.

One objection I’ve seen raised, for example in Fiona Tait’s article on Citywire, is that research shows that the huge majority of people stop paying into a pension fund once they take their lump sum. It’s an excellent article but I have to take issue with this. It’s simply a result of current legislation. If you can’t (crudely speaking) take your lump sum until you retire, it is no wonder that further contributions are rarely paid in.

For pension providers, paying the 25% tax-free lump sum means keeping records when new contributions are made or other pension funds are transferred in so that pension savers know what tax-free lump sum they are still entitled to. Fortunately, that is nothing new. Pension providers offering drawdown already do this: it is possible to begin taking benefits from part of the fund and continue to pay in contributions to the rest of it. It is not difficult and adds very little to the cost of providing drawdown. There would be a minor administrative saving, too: by removing the age limit, the consequent need to prove and record date of birth also goes.

Early access of any sort opens up the possibility of recycling money back into the pension to play the tax system. Rules to prevent this needn’t be complex. One potential solution would be a moratorium on paying in contributions for a certain period and the loss of carry forward. With a maximum tax-relievable contribution of £50,000 and only 25% available as a lump sum, the law of diminishing returns would set in quickly. HMRC already have the mechanism in place to monitor the level of contributions made to pensions schemes and the tax relief claimed, so again this seems to fit well with current systems and practice.

This option wins for pension savers for simplicity, low-cost and preserving 3/4 of the fund for providing retirement income. It also wins for providers and government for its compatibility with existing systems and legislation; they too benefit from its simplicity.

And the winner is ...

About sipphound

Chewing over pensions, saving and retirement issues. Sniffing around financial planning, personal finance, investing and behavioural influences. All personal opinions, no company represented and no advice given.
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