Pension transfers explained Pension unlocking
What is pension unlocking?
Pension unlocking allows you to draw an income from your pension before normal retirement age. If you are in a final-salary scheme, this usually involves transferring your fund to a personal pension first.
You can then take 25% of the fund as a cash-free lump sum, using the rest to buy an annuity or to provide an income directly from the fund, if required. Alternatively, you can take the 25% tax-free lump sum and leave the rest of your pension invested, ready to buy an annuity in the future.
What are the risks of unlocking my pension?
Taking your pension early (possible from age 55) means you’ll receive a much lower monthly income than if you waited until 65 as your annuity provider will have to pay out for an extra 10 years. While you’ll receive a pension for longer, taking your pension 10 years early also means you’ll lose out on those extra years of investment growth in your fund.
If your health deteriorates in the future you won’t be able to buy an enhanced annuity (which pays more to those with a lower-than-average life expectancy) as you’ll already have spent your pension fund.
Taking your pension early may also affect the level of state benefits to which you’re entitled, further reducing the appeal of unlocking.
What difference will it make to my retirement income?
We calculated the pension income received by a man using a £200,000 pension fund to buy an annuity at 55 in 2000. We compared this with what would have happened if he had left his pension fund invested, buying an annuity at 65 in 2010 instead. Even with the stock market upheavals of recent years, the dramatic fall in annuity rates and without making any extra contributions, the initial pension received by the man at 65 is around double what he would have received at 55. So long as he lives to 75, he will have received more income in total by waiting until 65.
If you’re thinking about pension unlocking, take advice from a specialist adviser. A company focusing solely on unlocking may not be able to advise you on all the alternatives. As Bob Bullivant of Annuity Direct says: ‘It’s vital to understand all options before making an informed decision. Pension unlocking smacks of looking for a solution before understanding the problem.’
To find out how to choose an independent financial adviser, and which qualifications to look out for, read the Which? guide to choosing a financial adviser.
Releasing your whole pension fund
‘Pension liberation’, whereby your whole pension fund is converted into cash, is not the same as pension unlocking. There is no legal way for most people to ‘liberate’ their whole pension fund before retirement, so you should be wary of any company claiming to help you do so.
Individuals between 60 and 75 whose total pension funds are worth £18,000 or less may be able to access their fund using the ‘trivial commutation’ rules, although three-quarters of this is liable for income tax.
Similarly, if you leave an employer after less than two years of service, you may be able to receive your own pension contributions back. However, you will not receive contributions made by your employer, and the amount you receive will be taxed.
Alternatives to pension unlocking
If you’re over 55 and need to access a lump sum or extra income, make sure you explore all avenues before opting for pension unlocking. These might include downsizing, sale of other assets, remortgaging, a short-term loan and checking that you’re receiving all the state benefits and tax credits to which you’re entitled. If you’re struggling with debt, take independent advice. For more detail, read the Which? guide to dealing with debt.