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Tax-free cash risks poor pension decisions, say MPs


Savers preoccupied with gaining access to their tax-free pension lump sum risk making poor investment decisions with the rest of their retirement pots, according to a parliamentary report calling on the regulator to take action.

Hundreds of thousands of savers reach the age of 55 each year, entitling them to take a quarter of their pension pot tax-free, with income tax payable on the remainder of their savings taken as a lump sum or income.

In practice, however, it is not always easy for savers to access their tax-free lump sum. This typically first involves transferring the pension pot from an “accumulation” or savings account to a new pension product with a “drawdown” feature.

In a recent inquiry, MPs on the House of Commons work and pensions select committee heard evidence that many people accessing their pensions for the first time were so “focused” on accessing the tax-free cash that they did not engage with the decision of what to do with the rest of their pot.

LCP, a firm of actuarial advisers, told MPs that “many people access their pension pot with the goal of accessing tax free cash, only to make poor use of their remaining savings, either by cashing out entirely (and depositing the balance in a cash account) or by moving the rest into a higher cost or worse-performing investment”.

The Investing and Saving Alliance, a financial services industry organisation, told the committee that many people were in drawdown by “default” because it was the route that they had to take to access tax-free cash.

In a report published on Tuesday, the MPs recommended that regulators look at ways to make it easier for savers to access the tax-free lump sum, while leaving the rest of the pot untouched. In theory, this would give savers more time to decide what to do with the majority of their pot.

“We heard from some witnesses that ‘decoupling’ the 25 per cent of a pension which is tax-free from the rest of the pot would prevent people defaulting into decisions against their best interest,” the committee said.

It recommended that regulators carry out research to explore the impact of “decoupling” and present their findings to the committee.

However, the MPs highlighted concerns that decoupling the tax-free lump sum may have “unintended consequences”, such as encouraging people to access more of their pension than they need because they believe it is normal to do so.

The Financial Conduct Authority said: “We welcome the report and will carefully consider the recommendations.”

Decoupling would require changes to the pensions tax regime and so would ultimately be a matter for government, it added.

The report also called on government and regulators to set up a trial in which more savers would be automatically enrolled into free Pension Wise guidance appointments.

“Without intervention to drive up dramatically the numbers receiving advice and guidance, savers will make poor decisions,” the committee said.

Stronger “nudge” measures, which come into force on June 1, will require occupational pension schemes to present Pension Wise guidance as a routine part of accessing pension savings. They must also offer to book a Pension Wise appointment for the individual, unless they wish to opt out of receiving guidance.

The Department for Work and Pensions was contacted for comment.

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