Serious concerns raised about savers raiding retirement pots

UK savers are raiding their pensions and spending their money too soon and too fast, according to a new report.

Last week, the interim report by the Pensions Commission set out the biggest challenges facing the UK pensions system between now and 2050.

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Concerns about under-saving dominated the headlines after the report was published – some 15 million people aren’t saving enough for a comfortable retirement, and just 4% of self-employed workers are actively saving into pensions. 

But the report also flagged concerns about the timing and size of savers’ withdrawals, suggesting that people could run out of money if they take too much out of their pension while they’re still relatively young and, quite possibly, still earning.

Headline findings

According to the report, half of all pensions are now fully cashed in the first time they’re accessed.

Of those who didn’t use the proceeds to generate retirement income, nearly a quarter were repaying debts, but 46% were spending it on a big one-off expense (such as a car or holiday), while 27% put the money in a savings account.

The report also warned that taking a tax-free lump sum had become a “no-brainer” – with 83% of people accessing a defined contribution (DC) pension since 2015 taking up the opportunity. “In savers’ minds, tax‐free cash has been effectively ‘decoupled’ from the bigger decisions on how to use a pension pot to fund a retirement,” the report said.

Likewise, huge numbers of savers are accessing DC pensions as soon as they possibly can. The age savers are most likely to dip into their pot is 55 (the current normal minimum pension age) – with 25% accessing their pension at that point.

And with earnings typically falling by around 20% the following year, the report suggested that savers were taking the opportunity to phase into retirement – reducing their working hours and using private pensions to top up their income.

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Then there’s withdrawal rates. The report found that a third of pots worth between £100,000 and £249,999 are being spent at a rate of 8% a year, suggesting that retirees are running the risk of outliving their savings.

Using the example of a £165,000 pot – after a 25% tax-free lump sum is taken – the report warned that savers taking out 8% a year would run out of money in around 10 years. To make their pot last 20 years, they would need to cut the withdrawals in half, to 4%.

But with the average 66-year-old woman (retiring in 2025) having a one in 10 chance of living until age 98, they could still end up outliving their pension by a decade or more.

Pension freedom fears

The publication of the report comes just over a decade after the introduction of the pension freedoms, which were implemented in 2015.

At that point, the government tore up the pensions rule book; savers were no longer automatically led down the annuity route and were able – for the first time – to manage their retirement savings themselves. Flexible pension drawdown became a mainstream and popular option, as did lump sum withdrawals.

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But this change also coincided with the decline of defined benefit (DB) pensions, which pay guaranteed income for life – meaning increasing numbers of retirees are now having to manage “longevity risk” themselves. It’s their responsibility to manage their savings, both in terms of how it’s invested and how much they withdraw, to ensure they don’t run out of cash before they die.

And that’s not an easy task for anyone. The report said that drawdown rates were sometimes based on “just guessing really” and that people weren’t thinking about their wider finances when they made withdrawals. 

For example, only 43% consider their life expectancy. Similarly, only 40% think about how much money they will need in the future and only 26% take the prospect of rising costs into consideration.

What do the findings mean?

Interested parties now have until 26 July to share their views on the interim report. A final version, with suggested recommendations, is expected in the spring of 2027.

Steve Webb is a partner at pensions consultancy LCP, but he was also the pensions minister between 2010 and 2015 and played a pivotal role in the pension freedoms.

He thinks that policy change may well be in the pipeline. This could include increasing minimum contributions for auto-enrolment to tackle under-saving, but it could also lead to tighter rules on pension access (decumulation).

“Although this is designed to be an evidence volume, it is already possible to see the outlines of some potential policy recommendations,” he said. “The report is particularly concerned about the decumulation phase where it is concerned about people accessing pensions early and in full, or maxing out on tax-free cash. Although pension freedoms will not be fully reversed, we can expect to see tighter rules, with a mix of later access to pensions and strong defaults steering people towards regular income rather than lump sum withdrawals.”

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The prospect of increased restrictions is unlikely to go down well. Writing in an article in The Times after the report was published, Webb urged policymakers not to make any regressive changes.

“The Pensions Commission report is negative about pension freedoms. It points out that some people use their freedom to access their pensions as soon as they can — age 55 at the moment, rising to 57 from 2028 — and may ease off on the amount of paid work that they do. But what’s wrong with that?”

He continued: “If people have worked hard and saved hard and built up enough pension to support a move to a shorter working week, isn’t it up to them? Getting people to sacrifice now so that they can build up an income for later through a pension can be a hard sell. The last thing we should be doing is disapproving when people enjoy the fruits of their self-control.”

And although half of pensions might be fully encashed in one go, rates of encashment vary hugely across different sized pots. For example, only 3% of pots over £100,000 are fully encashed, compared to 80% of small pots worth less than £10,000.

Cashing in a small pot could be an entirely sensible planning decision if you have other, more substantial pensions, to fund your retirement.

Nonetheless, the report does raise valid points about the complexity of managing retirement income – and it’s an issue that’s only set to become more complicated next year once pensions become subject to IHT and more savers strive to get money out of their taxable estate.

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It also shows that people don’t typically engage with pensions. More than three-quarters (77%) of people with DC pensions aged 40-75, didn’t have a plan for how they would access their pension, while 21% didn’t realise they would need to make a choice. More worrying was the fact that nearly a third didn’t know that their pension was invested.

There’s undoubtedly a risk that some people will mismanage their income in retirement. But reining in the pension freedoms isn’t the answer. Retirement looks different for everyone and that means we need a system that gives savers flexibility in terms of how they manage their income.

The focus now needs to be on education, engagement and how to make advice accessible for more retirees. Default solutions could also play a role too and help those who don’t want to manage their income.

The pension freedoms have been popular for a reason. Surely it’s better to give savers options and help them manage their income flexibly, rather than imposing tighter restrictions which could very well put even more people off saving in the first place?