Study warns of pension shortfall risks

4 November 2015   By Justin Schamotta

PEOPLE who cash in their pensions early run the risk of becoming penniless in their twilight years, according to research analysing similar schemes abroad.

retirement savings
Credit: Cozine/

The Social Market Foundation, an independent think tank, studied the behaviour of people in countries where pension freedoms similar to those recently introduced here are well established - namely, Australia and the US.

They found that very few people from either used their funds to buy annuities, which would give them a guaranteed income for life but have a reputation for being poor value.

Instead, most chose to draw down income from their pension pots, with a significant proportion getting through the money at an alarming rate.

Big spenders

According to the report, a quarter of Australians exhausted their pension pots by the age of 70, rising to 40% by the age of 75.

If we copied this behaviour in the UK, a man retiring now at the age of 65 would be left with no income for 12 years, based on an average life expectancy of 87.

A woman retiring now, who was guaranteed to reach the average life expectancy of 89, would need to survive for 14 years without any income from their private pension.

Evidence from the US is much the same.

It shows that retirees who use the income drawdown method of accessing their pension savings consume them "relatively quickly", with an average withdrawal rate of 8% per year.

Were we to follow the American example, the average British man retiring now would have to live for five years with no pension, while the average British woman would run out of money seven years before she died.

What's happening now?

While the behaviour of people in the Australia and the US is interesting, it's far from being an accurate prediction of how we in the UK will behave.

The UK reforms may only have come into force seven months ago, but we do have some early figures reflecting what's happening so far.

According to the HMRC, 146,000 people have cashed in their pension pots since April, withdrawing a total of £2.7 billion in the process.

Figures from the Association of British Insurers (ABI) suggest that the average withdrawal is around £15,000; it's typically used to upgrade the car, pay off debt, or go on holiday.

But according to Yvonne Braun of the ABI, other people "are taking a sensible approach and considering how they will pay for their retirement".

Novelty factor

Of course, it's relatively early days in the life of the pension freedoms scheme.

It's possible that once the novelty has worn off and having easier access to money that we once thought was going to be tied up somehow becomes the norm, then our temptation to spend unwisely might be subdued.

But Nigel Keohane, director of research at the Social Market Foundation, doesn't think so.

"We know that in the UK, the financial literacy and capability of the population is quite low," he says.

The Government have taken a similar view, though they blame a lack of "regulatory clarity" surrounding the scheme, rather than the "capability" of the population.

A recent investigation by the Commons Select Committee found that the pensions freedoms system wasn't "operating entirely as it should".

The study also said that the Pension Wise service - set up to offer guidance on the choices people have under the new pension freedoms - wasn't reaching people in the way it was intended to.

Making ends meet

Given that it'll be the Government who'll be left trying to make up the shortfall if people spend their pension early, the onus is on them to ensure we receive quality information.

At the moment, they already spend 42% of the total social security budget on pensions.

By the financial year 2022/2023, it's predicted that half of the entire welfare budget will go towards paying state pensions.

Those whose spend their pension pots now could exacerbate the problem, primarily by claiming other Government benefits, such as means-tested social care funding and council tax benefits.

Tom McPhail, head of pensions policy at investment firm Hargreaves Lansdown, agrees.

"The Government has been slow to track what people are doing with their freedoms and this should jolt them into action," he says. "To prevent a risk to the state we need a deeper understanding of how people are using their money.".

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