Thanks to the introduction of Pension Freedoms in 2015, if you contribute to a defined contribution pension scheme you now have far more flexibility when it comes to accessing your money. 

However, while it is now possible to cash in your whole pension pot, this might cost you in the long run.

New research from LCP shows that savers taking this option and cashing out from their pension pots has resulted in £2 billion in lost returns. These losses come from individuals moving their money out of their pensions – which often generate solid investment returns – and into low interest cash savings accounts.

This is possibly due to a lack of understanding as, according to This is Money, only one-third of people know that their pension is invested in the stock market. As such, they are unaware that their pensions benefit from stock market performance.

Given the current record low interest rates, taking money from your pension and depositing it into a cash savings account could severely damage your returns, and potentially put your retirement lifestyle at risk. Read on to find out why.

More than 1.7 million people took their full pension pot in cash

LCP quote figures from the Financial Conduct Authority, which state that between April 2015 and March 2020, just over 1.7 million people took their full pension pot as cash. Out of those, 32% put most of their money into a Cash ISA, savings, or current account.

That means that over half a million people took money out of a pension pot that potentially generated investment returns and put it into a savings account with next-to-no interest.

LCP believe that this move could have cost pension savers an estimated total of £2 billion in lost returns. They have reached this number by assuming that the average withdrawal age is 59, and that the money withdrawn from the pension stays in cash until the saver is aged 67, at which point it is drawn in full.

Knowing what to do with your pensions and how they work might help you in the future

LCP also believe that more should be done to educate people on their finances, especially their pensions.

Understanding exactly what their pension is, how it is invested, and how inflation and interest rates could affect their personal finance, could leave thousands of people better prepared for their retirement.

For some, cashing in their pension pot may have been the correct thing to do. Perhaps some of the money was needed for a specific reason, or perhaps they have other pensions that they plan to draw on later.

For many, however, it could be more beneficial for them to leave their pension invested, as this money could continue to generate returns in the future. Taking it out early could result in a less comfortable retirement.

When it comes to what you should do with your pension, it will be heavily determined by your personal circumstances.

With record low interest rates, keeping the money in a pension could generate higher returns

Interest rates on cash accounts are rarely above 0.5% so, even in the best-case scenario, you will not gain that much year-on-year if you take your pension and put it in a traditional savings account.

By leaving your pension fund invested, you could benefit from strong investment growth, depending on the performance of markets. This is often the case if you leave the money invested for the medium or long term. If you take your pension out at the average age of 59, you could be preventing many years’ worth of growth.

Putting your pension into a cash account could also see your savings eroded by inflation. The current UK inflation rate is 2.5%, according to an Office for National Statistics report. What this means is that on average, the price of goods across the UK in June 2021 was 2.5% more expensive than in June 2020.

If you had taken your pension pot and put it into a savings account, you would not only likely see a low interest rate on your savings, but your cash will likely also not be rising in line with inflation. This would mean that the purchasing power of your savings will decrease over time.

Transferring your pension into a savings account can inhibit its growth and reduce its value in real terms.

The final thing to be aware of here is that, when you take your entire pension pot as a lump sum, only the first 25% will usually be tax-free. The remaining 75% will be taxed as earnings. This means that taking your pot in one go could see you face a large tax bill.

Get in touch

If you would like to discuss the risk of inflation on your wealth and how you may be able to mitigate it, please contact us on 0800 434 6337.