Like it or lump it time nears for pensions

INVESTORS who are planning to take cash out of their pension to beat next April's deadline are being advised to set the wheels in motion now, as the process can be complex and fraught with delays.

Currently, anyone aged over 50 can release 25 per cent of their pension savings by taking a tax-free lump sum. From April, this is only available to the over-55s, so is being withdrawn from the 50-54 generation.

Conventional wisdom suggests it is unwise to take money from a pension until you are ready to stop work. However, increasingly some pension savers are asking themselves whether they would be better off cashing in part to, for example, pay off a mortgage or other debts.

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This trend has accelerated as household budgets have been squeezed, with credit harder to come by. Currently, nearly 30 per cent of those taking out unsecured pensions, which allow cash to be taken early, are under 55.

But it involves a convoluted operation, fraught with pitfalls. Furthermore, for many pension savers, such a move should be the last resort, as they could lose far more than they gain. Here we answer some key questions to help you through the maze.

Where is best to begin?

Unfortunately, it's not just a case of writing to the pension provider and asking to withdraw cash.

The claimant must effectively retire. This doesn't mean stopping work, but the existing pension arrangement must cease.

Is it best to take everything out?

Not exactly. A quarter (25 per cent) can be taken out but the rest must be transferred to either an income drawdown scheme or an annuity. With an income drawdown, the money continues to be managed in a fund, and nothing actually needs to be drawn down. Unfortunately, charges will be levied against the fund, which doesn't make this a sensible option for anyone with less than 100,000 to invest.

An annuity will pay an income for the rest of your life, but the younger the claimant, the smaller that income will be.

Is buying an annuity a poor deal?

This is what conventional wisdom always dictated. However, annuity rates have already deteriorated to such an extent that advisers are now arguing, if life expectancy is good, an annuity might be the best option. The break-even point is somewhere in the late 70s for most annuity buyers. If there is only a small pot of money, an annuity might be the only option.

How can the value of a pension be established?

The pension provider can be asked for a transfer value. There may be a delay, particularly if there is any dispute about the quote. It should be more straightforward for those with a personal pension, who can ask for a transfer value and meanwhile shop around for a low-cost drawdown arrangement, such as those offered by Aegon, Hargreaves Lansdown and Killik & Co.

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Alternatively, it might be time to shop for an annuity. Once given a transfer value, the provider should be asked to provide tax-free cash and transfer the remainder to the annuity provider.

Is it wise to have a financial adviser?

If the pension pot is small, it may not be worthwhile to employ an adviser. If the pot is significant, advice should be sought.

Is it possible to take cash from an employer scheme?

Yes, but this should never be embarked upon lightly, because employer contributions could be lost for good. If you have a group personal pension or group stakeholder into which your employer is also contributing, ask whether you can rejoin the scheme after you have left it to take cash.

If the answer is yes, then you are effectively in the same position as independent personal pension policyholders. You can cash your investment in and then start again.

However, if the rump of your pension goes into drawdown, you must pay the charges, which your employer may have been meeting. This will cut your pension long-term.

What about trust-based schemes?

If you have a trust-based money purchase or final salary scheme, it is extremely unlikely that your employer will allow you to leave the scheme and rejoin, which means you are not only surrendering your past pension contributions but foregoing significant employer investment in your retirement. As these contributions are effectively deferred pay, you will be shortchanging yourself significantly.

The position is even worse for final salary schemes. Unless you are actually giving up work, by cashing in your pension you are surrendering valuable guarantees which will offer considerable peace of mind in retirement, and which you could not afford to buy yourself. Similarly, you will almost certainly not be allowed to rejoin the scheme, so will lose future employer contributions.

Finally, when you take a transfer value from a final salary scheme, you are unlikely to be given an equivalent to its full worth. So you will be shortchanged again.

Are there any other penalties?

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Most older-style pensions asked you to quote a target retirement date. Retiring early may involve early surrender fees. Investments may also involve penalties, such as with-profits, where market value adjusters can be imposed which could cut your transfer value by anything up to a third.