When pension temptation strikes: How employers can support older workers
Ahead of this year's Budget, there have been suggestions that the level of tax-free lump sums available from pension schemes could be capped at £40,000, down from its current level of 25% of a pension pot, up to a maximum of £268,275.
Inevitably this could lead to a significant number of people drawing out sums in advance of any change coming into force, dependent on what any transitional arrangements might look like. Employers will be paying attention to what happens here.
Regardless of whether the Chancellor introduces such a change, businesses should still consider whether they are offering the right support to employees and members to help them deal with the temptation of tax-free money.
Would you like tax-free windfall?
An employee reaches a certain age and suddenly, they can get their hands on the biggest chunk of change they’ve had in their lifetime.
The reason for starting a pension was to provide income when their salary stops, but as that 55th birthday approaches, the lottery effect kicks in; the emotional side of the brain goes into overdrive.
Feelings-led decisions, ignoring logic, can certainly lead to regret. But could this money get someone out of a financial jam, relieve depression, or make their partner or children happy?
The fear of missing out (FOMO) is real too – especially with the constant stimulation of social media showcasing how others are spending cash. Temptation is calling.
What’s the catch?
Well, the consequences obviously vary.
With a retirement age of 65, the average employee, taking £25,000 cash at 55, might have to save around £240 per month extra, assuming they need to replace the withdrawn funds; they could always work longer.
There are, of course, many good reasons why it might make sense to access a lump sum early. I’m more concerned with the people too focussed on the short-term, making themselves (and potentially loved ones) happy today. Have they come to a balanced-decision or simply turned a blind eye to the longer-term consequences? It’s confirmation bias in action.
We read about members burning through pension pots at unsustainable rates. This is because they can and because of how we as humans are built. Pension freedom was certainly a positive step but did introduce a very predictable risk that seems to be materialising.
Common sense suggests if an employee is unable to afford to retire, they will carry on working, whether they want to or not. Absenteeism and presenteeism can result, with a potentially negative ripple effect on the wider workplace culture and environment.
The responsibility
Absolutely, this sits, first and foremost, with the member themselves. But for employers, ensuring their employees save enough and use pension savings effectively is important. There is the duty of care perspective, but there are also sound commercial reasons too.
Beyond funding contributions, most employers will rightly have an expectation that their pension providers will do most of the heavy lifting regarding positive outcomes.
In relation to the effective use of tax-free lump sums, here are some questions employers might want to consider, testing both their providers but also whether they might want to offer support independently.
If education is provided close to when to when the money is available, the decision may have already been made. People are unlikely to change their mind – particularly if it’s already been spent, emotionally speaking.
Perhaps specific engagement regarding potential consequences should be provided well in advance, as much as 10 years prior to the option being available.
Are psychological aspects explained?
If the focus is on how the pension works, will employees just hear that access at 55 (or 57 from 2028) is an option and the temptation grows? Explanation of the psychological and decision-making processes we all go through can help lead to more balanced choices.
Logic and emotion both play a role. There is also mention of neurodiversity implications and the impact of different personality types on decision-making as positive steps.
Do you want to cope with less, save more or retire later? Confirming the fund will be lower doesn’t go far enough. Recycling and the potential triggering of the Money Purchase Annual Allowance will typically be highlighted but may not be understood.
A good idea is to allocate identity to different parts of pension pots e.g. this part of your pension pot might be needed to cover your essentials in retirement - tells you maybe don’t’ spend this money early on that holiday of a lifetime.
Link between investment choice and access
Default funds change regularly, it seems. Do employees understand the related investment considerations at the point of withdrawal? Have they managed investments accordingly and is now a good time to sell?
It’s possible your provider doesn’t offer the ability to take a tax-free element and leave taxable savings untouched. Complexity and costs might push members to choose the easiest path, even if it’s not the best financial decision.
Will the provider pass members to financial advisers who work for the same firm? You may see this as positive and have carried out relevant due diligence. You may want to offer more independence or keep your distance from any regulated transaction.
The conclusion
The temptation is powerful and understandable. Without careful planning and the right education at the right times, long-term security and wellbeing can certainly be undermined.
Employers don’t make the decision, but they can and should ensure there is a pathway to accessing funds that minimises the possibility of regret – for all the parties concerned.
Supplied by REBA Associate Member, Verlingue
Verlingue – an independent, family-owned Employee Benefits consultant supporting UK and multinational businesses with Retirement, Reward, Healthcare and Protection consultancy and advice.
