In the five years since pension freedoms were introduced, just over 1.7 million people took their full pot out in cash, according to the latest statistics by the Financial Conduct Authority (FCA).
Between 2018 and 2020, the average withdrawn sum was of around £12,500.
But advisory firm LCP suggests that entering drawdown could cost savers £2bn ($2.7bn, €2.3bn).
Such losses stem from the fact that they are taking money from a pension that was invested for growth to move it into a cash account paying “little or no interest”.
In its 2017 ‘Retirement Outcomes Review’, the FCA found that 32% of retirees that took advantage of pension freedoms put most of their money in an Isa, savings or current account “to either drawdown or keep as a safety net”; while 20% invested the largest share in capital growth.
LCP said that if the 32% figure is applied to the 1.7 million people who took money from their pension in full, that suggests that around 555,000 savers took their pots and put it in a cash account or similar.
Interest rates in such accounts vary but are still very low at around 0.5% or less, whereas they would yield an expected return of 4.4% if they left money in a pension, based on official assumptions.
This means a yearly loss in returns of around 3.9%.
Missing out on returns
Additionally, FCA data shows that over three quarters of withdrawals are taken by people aged between 55 and 64, suggesting that the money will probably stay in a cash account for several years before it’s used to support retirement income.
LCP said that, by assuming a typical average withdrawal age of 59 with the money sitting in a cash account until the state pension age at 67, people who have taken out their pots in full since 2015 will suffer a collective loss in returns of £2bn.
For the 555,000 people calculated above, this would mean losing on average £3,500 each.
This, of course, is based on the assumption that they don’t move their funds into a vehicle that could generate better returns.
LCP’s calculations also exclude withdrawals from occupation pensions which could easily increase the scale of the problem, the firm said.
That is why the advisory firm believes that people should be given the opportunity to cash in their 25% tax-free lump sum but “leave the rest behind” in their pension to make sure they are not losing out on returns.
A serious dent to retirees’ wealth
Laura Myers, partner and head of defined contribution at LCP, 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, added: “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”.
