Personal finance: Raiding pension a long-term risk

Loosening those shackles now is a long-term risk. Picture: Contributed

Workers retiring with debts spend an average of £332 a month on repaying them, according to research from Fidelity Worldwide, which found that two in five retirees don’t expect ever to be free of that burden.

It claimed that the pension freedoms coming into force next April will give retirees a new way of clearing their debts. Under the changes, set out in the Budget in March, retirees will be able to cash in their entire pension pot, including 25 per cent tax-free. The remainder will be taxed at the individual’s marginal rate, rather than the current 55 per cent charge.

With more than half of retirees expecting their outgoings to rise over the next five years, according to Fidelity, it seems inevitable that pension cash will be viewed as a financial panacea.

One in six already uses pension savings to pay off loans and credit cards, to the tune of £269 a month, on average, while almost one in ten people  retire with a mortgage to clear.

Alan Higham, retirement director at Fidelity Worldwide Investment, said: “Too often retirees are portrayed as being uniformly well off, however the research shows a significant minority are in financial distress.

“Pension freedom can allow them to become debt free quickly by accessing their pension fund savings.”

But while pension cash will for some retirees provide a valid solution, those viewing it as a way of clearing their debts risk finding themselves in even deeper financial difficulty.

Sarah Tory, financial adviser at Shepherd & Wedderburn Financial in Edinburgh, said that paying off expensive debt is always high on the agenda at retirement.

“The new freedoms could give individuals an opportunity to clear these and start afresh,” said Tory. “But fundamentally the pension is there to provide income for what could be a very long retirement and large sums will be needed to fund that income requirement.“

While turning to pension savings to gain freedom from the shackles of debt might seem logical, she added, it can also be unwise.

“I would caution the pension being considered something that can deal with debts at a later date. The last thing we need is them being seen as a repayment vehicle,” said Tory.

“In future, stripping out capital to pay for debt could drastically reduce required income and also have some unpleasant tax consequences.”

Advice is strongly recommended for anyone likely to dip into their pension to clear debts. That advice is most effective when taken long before retirement, said Tory.

“It comes back to sound financial planning in the early years to ensure people set targets to repay debt before retirement so that the hard saved pension pot can be used as it was intended – to fund income in retirement.”

The Fidelity research was published as another report estimated that the average 65-year old retiring this year can anticipate living 20 more years.

Providing the average expected retirement income of £15,800 a year throughout that period would require a pension pot worth at least £121,000 at 65, according to analysis by Prudential, based on a combination of drawdown and state benefits.

Someone retiring today and living for 25 more years would need a pension worth almost £140,000 at retirement to secure the same expected annual income.

Vince Smith-Hughes, retirement income expert at Prudential, said the pension freedoms being introduced next year would give savers greater choice.

“However, these new figures underline the importance of making retirement income decisions that address the risk of outliving your savings. If retirees choose to draw income directly from their pension fund, they need to consider if it’s sustainable to take that level of income over an extended number of years.”