Pension unlocking What is pension unlocking? Unlocking your pension, also sometimes called 'pension release' describes the taking of pension benefits before you actually retire. Pension unlocking is a high-risk option that is not suitable for most people. Provided that you are over 50 (this age limit rises to age 55 in 2010), you may take up to 25% of a pension fund as a tax-free lump sum (more properly known now as a pension commencement lump sum). You may do this without having to retire straight away or draw an income from it. Alternatively you may take the tax-free lump sum and buy an annuity. In a final salary scheme it is possible that the income you give up by unlocking your pension may well be worth more than the tax-free cash available to you. The pension given up in a final salary scheme is calculated using 'commutation rates'. This relatively complex calculation effectively means that, for example, you would give up £1 of annual pension income for each additional £12 of tax-free cash. The exact rate applied by your pension scheme may be different, commutation rates vary depending on scheme rules. If you are considering unlocking your pension, whether a defined contribution pension or an occupational final salary scheme, you must be aware that taking your pension early, while increasing your standard of living now, may significantly reduce the value of the pension you receive in retirement. It is vital that you consider how this will affect you before considering this course of action. What are the alternatives to pension unlocking? Most people who consider unlocking their pension do so because they need the money but there are other options that can also satisfy the need for cash without impacting on future pension income. Pension unlocking may reduce your retirement benefits and is not suitable for the majority of people or circumstances. It should only be considered as a very last resort. Among the alternatives to unlocking your pension are: • Debt consolidation • Remortgaging • A secured loan • The use of other assets • Applying for State assistance Any or indeed all of these options may offer better long-term value to you than unlocking your pension. Debt consolidation - if you are thinking about accessing the tax free cash available within your pension scheme to deal with debt, you should first carefully explore all your other debt consolidation options, such as moving debts to cheaper credit cards, taking out a structured personal loan to deal with credit card debt or a secured loan. Remortgaging - you may wish to use the tax free cash to create extra income or even to fund the purchase of a retirement home overseas. In either case it may make more sense to consider using some of the equity in your home to take advantage of the rise in house prices over the last decade. This way you won't be reducing your likely income in retirement. Secured loan - Remortgaging may not be an option if you are tied into a specific mortgage deal. A secured loan could be a more suitable option. Bear in mind also that pension unlocking can be a time consuming process whereas you would actually be able to get funds from a secured lender much more quickly. Use other assets - do you have other assets that you could realise to create a cash sum. Have you perhaps considered even downsizing your mortgage by moving to a smaller home, thereby releasing the equity in your family home and realising the cash value? Applying for State assistance - if you have no other options available to assist in boosting your income now, it is worth looking closely at the State benefits system. You may find that you are eligible for substantial help. Many people who consider pension unlocking do so because they have been forced to take a drop in income through ill health, unemployment, etc. In these cases, before looking to unlock your pension and adversely affect your future income in retirement, look first to your benefits entitlement. Consider the costs of meeting your financial objective by alternative means and compare this with both the short and long term costs of unlocking your pension. Pension unlocking is unsuitable for most people and you would normally be best advised against doing so. How much can I unlock? Your pension scheme, whether private or occupational, whether defined contribution or defined benefit, is designed to provide you with an income in retirement. The government allows generous tax breaks for pensions savings and allows you to kick-start your pension with an equally generous tax free sum from your pension pot although the rest of your pension income is taxable. Under most pension schemes you may take up to 25% of your pension fund as a tax free lump sum (pension commencement lump sum). Thus a private pension fund worth £50,000 would offer a lump sum payment of £12,500 (before any fees or product provider charges where applicable are taken into account). The actual size of the lump sum potentially available will depend on the size and type of pension benefits you hold. Once you have taken this lump sum, you can't take any more tax-free cash from your pension. Pension unlocking may reduce your retirement benefits and is not suitable for the majority of people or circumstances. What impact could it have on my pension? The key thing to remember is that you would be taking the pension benefit early. This has obvious knock-on impacts. First, by taking the cash out up to 10-15 years early, you will get a smaller income; second, you will be missing out on that 10-15 years growth in the value of your pension fund as well. The Financial Services Authority (FSA), the UK financial watchdog, cites the example at the end of this article based on a real case. However, no two situations are identical and figures will vary from case to case depending on individual circumstances and specific pension fund rules. Is pension unlocking right for me? If you have an immediate urgent need for cash, pension unlocking may not be suitable - pensions can be complex and this is reflected in the length of time it takes to unlock pension benefits. In some cases this may take several months. Your pension plan is primarily intended to provide an income for you / your family after you retire. Drawing on that resource before you reach retirement is likely to have an adverse impact on your retirement objectives. You should be sure you have considered this fully before making the decision to take retirement benefits early. If you have an occupational pension scheme your first step would be to talk to your pension scheme trustees to find out what your current and forecast benefits might be. If you have a personal pension, you may contact the pension provider for an illustration of what your benefits may be now and if you waited. Releasing cash from your pension may be a tempting option but you need to stop and think about whether you really need to do it. It is rarely in your long-term financial interests. Only in exceptional cases, where you have no other option, should you ever consider doing it. Will pension unlocking affect my State benefits? You may unlock your pension and continue to work. There is no need to retire from employment. Your State pension does not automatically become payable as a result of unlocking a personal pension or occupational pension scheme. However, pension unlocking tends to appeal to people who have been made redundant or who have little or no savings. Such people are also likely to be in receipt of a variety of State benefits. Many of these benefits are means-tested. Any substantial change in your financial circumstances, such as may be brought about by unlocking your pension, may jeopardise the value of the benefits you receive. You may find yourself no better off financially as a result. What questions do I need to ask? The Financial Services Authority identifies four key questions you should ask yourself before progressing with pension unlocking: • How much cash do I actually need now? • Would I be better off borrowing the money? • Should I consider selling or cashing other investments / assets? • If I cash in my pension fund(s) now, will I have enough to live on in retirement? You should also consider the following questions as well: • What benefits am I giving up such as ill-health benefits or death benefits? • What impact would unlocking my pension have on my State benefits or tax position? • What penalties may I incur by unlocking my pension? • How much will I have to pay in fees and charges to get my money early? • How much will I have to pay an adviser for unlocking my pension? You should consider every other option very carefully before thinking about cashing your pension in early. If you unlock your pension, your income will probably be considerably less than you could expect if you waited until your retirement date. You may only use a pension fund once. If you unlock it early, you will have less to live on when you retire. Pension unlocking is only suitable for a very limited number of people and circumstances. Where can I go for further information? Remember that there are many alternatives to pension unlocking. Advice and counselling are available from a variety of sources: Citizens' Advice Bureaux See phone book for local branch www.citizensadvice.org.uk Advice UK 020 74707 4070 www.adviceuk.org.uk Citizens Advice Scotland See phone book for local branch www.cas.org.uk Consumer Credit Counselling Service 0800 138 1111 www.cccs.co.uk Money Advice Scotland 0141 572 0237 www.moneyadvicescotland.org.uk Community Legal Service (England and Wales) 0845 123 2321 www.clsdirect.org.uk National Debtline 0808 808 4000 www.nationaldebtline.co.uk Financial Services Authority www.fsa.gov.uk Directgov www.direct.gov.uk/en/index.htm Pension unlocking is unsuitable for most people and circumstances and may reduce your retirement income. It is vital that you think about how this will affect you. Wednesday, December 03, 2008 The information below is taken from the FSA website Unlocking your pension can mean money today, misery tomorrow, warns FSA FSA/PN/014/2003 28/01/2003 The Financial Services Authority (FSA) is today alerting consumers to the potential pitfalls of cashing in their pension pot before they retire. So-called "pension unlocking allows someone over the age of 50 to release their pension benefits from an occupational or personal pension before they have reached their retirement age. The benefits are transferred to a new pension arrangement from which they can release their money. They can then take a tax-free lump sum from their pension fund and use the remainder to buy an annuity. This will, however, substantially reduce the income available to them in retirement. A new FSA consumer alert, published today, gives an example of a man whose post-retirement income will be substantially cut, perhaps by over 80%, because he "unlocked" his pension pot 12 years before his retirement age. David Kenmir, Director of Investment Firms at the FSA, said: "Releasing cash may sound very tempting but you need to stop and think about whether you really need to do it. It is rarely in anyones long term financial interests. Only in exceptional cases, where you have immediate needs and no other option, should you even consider doing it. Its an expensive way to free up extra cash and, in addition, your financial adviser may well take a fee for dealing with it meaning that part of your hard earned pension pot will benefit him rather than you! It will affect your income and retirement for the rest of your life - there are likely to be better ways to address any short term cash needs so think very carefully about it." The FSA suggests consumers ask themselves the following questions before deciding whether or not to unlock their pension: • How much cash do I actually need now? • Would I be better off borrowing the money? • Should I consider selling or cashing in other investments? • If I cash in my pension fund(s) now, will I have enough to live on in retirement? The FSAs consumer alert, published today on its web site at www.fsa.gov.uk/consumer under Whats New, gives further information to consumers. Included in this information are additional questions that a consumer should ask their adviser. For consumers who do not have access to the internet, free printed copies may be ordered from the FSA Consumer Helpline on 0845 606 1234. The FSA is looking at firms that are engaged in this activity and will take relevant action to protect consumers where necessary. This may include enforcement action if the regulator finds that customers have been exposed to misleading financial promotions or inappropriate advice. If consumers have unlocked their pension and have concerns, they should take the matter up with the firm that advised them to take this action. 1. Example Case The following is based on a real case. However, no two situations are identical and figures will vary from case to case depending on individual circumstances and specific pension fund rules. In 2002 Mr X, age 53, 'unlocked' a pension he had with a former employer. This pension was a defined benefit (final salary) scheme. His pension fund had a transfer value of 11,256. This was transferred into a combination of a personal pension plan and a Section 32 buy- out plan. Mr X could have taken early retirement benefits from his pension scheme. The comparative benefits of doing this, or waiting till normal retirement date, are set out below. Benefits at normal Benefits from Benefits if taken from retirement date (age 'unlocking pension' at original scheme at age 65) from original age 53 53 (early retirement) scheme Tax-free cash 4,337 (after fee) 4,606 4,783 Annuity or equivalent 91 a year 516 a year N/A now Annuity or equivalent 340 a year** 693 a year* 1,824 a year at age 65 **91 + Protected Rights pension assuming investment growth of 5% over 12 years Equivalent figures at 7% & 9% are 462 a year and 630 a year respectively *516 increasing @ 2.5% a year over 12 years Notes We have not considered plan guarantees, such as spouses benefit, fixed term annuities etc. Financial advisers normally charge a fee for arranging such transactions. In this example the adviser has charged 482 which has been deducted from the tax-free cash released. In addition the adviser has received commission of 720 for the transfer from the new pension provider. 2. Consumers are targeted through press and television advertising as well as mailshots. 3. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; the appropriate degree of protection of consumers; and fighting financial crime. 4. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.
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