New research from consultants LCP suggests that savers cashing out pension pots to take advantage of ‘pension freedoms’ since 2015 are set to lose £2bn as a result. The losses come from moving money from a pension where it was being invested for growth into a cash account paying little or no interest. LCP argue that this problem should be tackled by allowing savers aged 55+ to easily access their 25% tax-free lump sum whilst leaving the rest ‘behind’ still being invested in their pension.

The Financial Conduct Authority (FCA) publish regular statistics on the number of people who have accessed a pension pot for the first time. The figures show how many people took the whole lot in cash, how many bought an annuity, how many went into drawdown etc. The most recent data also provides a breakdown by pot size.

The FCA figures show that:

• Between April 2015 and March 2020, just over 1.7m people took their full pension pot out in cash;
• More detailed data for the period 2018-2020 suggests that the average fully encashed pot was worth around £12,500;

After the introduction of Pension Freedoms, the FCA undertook a ‘Retirement Outcomes Review’ and part of this research looked at consumers who fully withdrew their pots, and asked them what they did with the money. The FCA found:

“32% put the majority of the money in an ISA, savings or current account to either drawdown or keep as a safety net”; 

(Source: Figure 4, p9, interim report, retirement outcomes review, FCA, July 2017)

The majority of these would be cash accounts (as opposed to stocks and shares ISAs), as the FCA identify a separate category of 20% who invested the largest share in ‘capital growth’;

Applying the 32% figure to the 1.7m who have taken cash out in full suggests that 555,000 people took cash from a pension and put it in a cash account or similar.

Interest rates payable on cash accounts will vary, but many savers will be earning 0.5% or less on cash deposits. By contrast, money left in a pension and invested in a mix of stocks and bonds would yield an expected return of 4.4% based on official assumptions (see notes). Moving money from a pension into a cash ISA or similar product could therefore produce a loss in returns of around 3.9% per year.

FCA data also shows that over three quarters of all full encashments are taken by those aged between 55 and 64, suggesting that the money may stay in a cash account for several years and then only then be used to support income in retirement. For simplicity, we assume that

• The typical withdrawal is at 59 (the midpoint between 55 and 64);
• The money stays in cash until state pension age at 67 when it is drawn in full;

Based purely on these assumptions and official data cited above, we estimate that just over half a million people who have taken their pension pot in full since 2015 and put the money in a cash account will suffer a collective loss in returns of £2 billion, assuming that they do not take action to move the money to somewhere where it will generate better returns. This is based on 555,000 people losing an average of £3,500 each.

Clearly the figure could be lower if people move their money out of cash accounts sooner than this, but could be higher if the money is literally in current accounts earning zero interest. Furthermore, these figures exclude withdrawals from occupational pensions which would increase the overall scale of the problem. As a result, we believe that a multi-billion pound loss is a realistic assessment of the actual (and future) loss to those who have cashed out in full.

This huge loss points to two key policy recommendations:

• Where money has already been cashed out and is sitting in a cash account, more must be done to alert consumers to the fact they are facing negative real returns; with a headline interest rate of 0.5% and inflation now at 2.1%, these savers are facing real losses of 1.6% per year even ignoring the fact that this money could have been sitting in a pension instead;
• Savers who want to access cash from their pension should be able to take 25% tax free but leave the rest ‘behind’ in their pension;  although savers can currently put the ‘other 75%’ in a drawdown account, this can sometimes be complex and involve choosing a new product or facing increased charges;  many savers with modest pots take the ‘line of least resistance’ and take the whole lot in cash but then have no real plan for the other 75% beyond the tax free lump sum.

Further evidence of the scale of the problem came in ISA statistics published by the Government on 8th June.  These showed that there are now 9.7m cash ISA accounts compared with just 2.7m stocks and shares ISAs, and that in the most recent year (2019/20) around twice as much money (£48.7 billion) flowed into cash ISAs as into stocks and shares ISAs (£24.2 billion).

Commenting, LCP Partner and Head of Defined Contribution, Laura Myers said:

“Savers who withdraw their entire pension pot and move most of it into a cash account are at risk of seriously damaging their wealth. Interest rates on cash accounts are currently well below the rate of inflation, meaning money left in such accounts for the long-term will steadily erode in value. The attraction of tax-free cash is well understood but it should be much easier for savers to leave the rest of their money behind inside the pension where it will continue to be invested for growth until they need it”.

Steve Webb, LCP partner, said:

“Putting money in a cash account can seem safe, but the only thing that is guaranteed at the moment is that you will see your spending power decline year after year. For those who have already used their freedom to take their pension pot in full, more needs to be done to alert them to the real losses they will suffer if they simply park their savings in a cash account. And we need to ‘de-couple’ the act of accessing tax-free cash from accessing the rest of your pension. Unless things change, hundreds of thousands more people could find they are not making the best use of their hard-earned savings”.