Tax-free pension withdrawals 'putting retirements at risk'

Pension savers can access 25% of their pension pot tax-free, usually from the age of 55. But it's important to consider how withdrawing from your pension savings could end up having a detrimental impact on your retirement.

Since the pension freedoms were introduced in 2015, people have a lot more choice in how and when to access their pension fund. Your options for taking your personal pension are:

• withdraw some or all of your pension pot as a cash lump sum
• use some or all of your pension pot to buy an annuity
• income drawdown -- take an income from your pension pot, while the rest is left invested

You can also combine these options. However, it's always worth getting financial advice before making decisions about your pension savings.

There are concerns that future pensioners are putting their retirement at risk by withdrawing cash from their pension pots while still in the accumulation phase.

A study by Legal & General Investment Management of more than 1,500 members of defined contribution pension schemes found that 28% of those who took either a lump sum or a recurring income were still contributing to their pension pots.

Over half of those who had withdrawn a lump sum said they did not need to take as much at that time and nearly one-third (29%) said that they could have used other savings, instead of taking the lump sum out of their pension.

As many as three-quarters (76%) of respondents did not intend to use their tax-free cash to provide them with an income in retirement. The most popular choice of what to do with the lump sum (27%) is to spend it on home repairs and improvements.

The tax-free aspect of taking a lump sum at the age of 55 is a clear driver behind this behaviour, the financial services firm said. Nearly half (46%) would not have withdrawn their cash if it had not been free of tax, and more than a quarter (26%) withdrew from their pension as soon as possible at the age of 55, with many unaware of the potential for growth had they kept their money invested for longer.

Savers may also be unaware of the risk that making tax-free withdrawals could actually lead to less tax-efficient outcomes, by reducing the amount you can pay in to your pension, tax-free.

The findings highlight the fact that the decision on when to take cash from pension pots -- and how much to take -- is often not based on financial planning.

"Rather than its original intention of incentivising saving, tax-free cash allowances appear to have the opposite effect in practice -- encouraging members of pension schemes to spend more before they retire and take their tax-free cash savings whilst they still have other sources of cash savings," said Rita Butler-Jones, co-head of Defined Contribution at Legal & General Investment Management.

"This is a potentially very damaging situation for whole generations of future retirees. Freedom today is hurting freedom tomorrow."