Instilling a savings culture, not a spending culture

The over 55s are taking full advantage of Chancellor George Osborne’s open door pensions cash withdrawals policy. In the first three months following April’s introduction of the reforms, pension savers have withdrawn a massive £2.5bn from their pots as cash. That is more than double the £990m they have put towards buying a regular income for life through an annuity.

While clearing debt, spending money on home improvements or going on holiday will make sense for some, easy access to pension cash does carry risks – for both employees and employers.

Foremost is the very real risk that retirees get through their pot too quickly, leaving them with nothing but state pension and benefits to live off years down the line.

But there is also the risk that people over the age of 55 who are still in work will start tapping into their pension pot as an easy source of ready cash.

Responsible and forward-looking employers will want to discourage such behaviour for a number of reasons.

Firstly, where individuals access their cash before they stop working they will usually end up paying considerably more tax than they need to.

While 25 per cent of pension withdrawals are tax-free, the remaining 75 per cent is treated as income in the year it is received. So somebody earning £35,000 who withdraws a £20,000 pot as cash will receive £5,000 cash tax-free but will be liable for income tax on the other £15,000. That will take their taxable income to £50,000, landing them with a tax bill of 40 per cent tax on everything over £42,385.

Wait until you stop working to draw your pension and most people find their income is so low that they are taxed at the basic rate of 20 per cent, or in some cases not taxed at all.

Withdrawing cash from a pension while still working has other consequences for employees. Anyone who withdraws a penny more than the tax-free cash element from their pot is restricted in the amount they can put into a pension in the future.

Their annual pension contribution allowance is slashed from £40,000 a year to £10,000. While most people will never contribute more than £10,000 in a single year, circumstances can change, and some individuals could end up regretting having made a cash withdrawal.

From an employer’s perspective, a culture of staff withdrawing their pension pot before retirement will not be welcome. The default retirement age was abolished several years ago, meaning employees can no longer be asked to leave at state retirement age. Rather than running a workforce of ageing workers that want to retire but cannot afford to, far better to ensure staff have a pot of money to take with them when they retire.

That is why communicating the value of long term saving and the tax advantages of pensions is essential if employers are to ensure staff engage with their pots for the right reasons. For employers it makes more sense to encourage staff to increase their contributions, highlighting the benefits of tax relief and compound growth, rather than withdrawals.

As a paternalistic employer you want the contributions you make to go towards providing for your employees’ retirement, not discretionary spending. Working life is the time for pension saving, not pension spending.

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