Should I unlock my pension to pay off debts?

Annie Shaw / 23 December 2013

Annie Shaw answers a Saga reader's pension dilemma in her latest online Q&A.



A reader writes: 

I’ve got quite a few debts and would like to release some cash from my pension to pay them off. I’ve heard about “pension unlocking” and have read that it is a bad idea. However, it looks like the ideal solution for me. Can you explain exactly why it is not something I should be considering?

I could alternatively just retire and take my pension now and release the tax-free cash, but I am quite happy at work and don’t want to pack in my job – and, of course, if I stop work now my pension will be smaller than if I retired in a few years’ time. Have you any suggestions?

Annie Shaw replies: 

You don’t say how old you are, and your options will be determined by this.

Pension unlocking is a way of releasing money that has been saved up for your retirement, but the devil is in the detail about how it is done and whether it is a good idea.

Let’s be clear, money set aside for your retirement is supposed to be just that – funds to keep you on the right side of the bread line when you are no longer working. That said, some people have urgent needs for cash prior to giving up work and using money they have saved to pay off current debts can seem tempting.

Avoid 'pension liberation' scams

The pension rules say that you can’t take money out or your pension fund until at least the age of 55. There’s a device, often referred to as “pension liberation” that has been widely peddled to under-55s by unscrupulous salesmen. It involves a convoluted arrangement which basically gives you a loan now in exchange for handing over the tax-free cash that many pension schemes offer at retirement. The downside is that scamster firms charge an arm and a leg in fees for their services, so you definitely won’t get your money’s worth.

The City watchdog has declared that what these firms are doing is illegal, and is warning consumers against them.

HM Revenue and Customs also levies a tax charge on money taken out of schemes in this way, so you could end up losing most if not all of your money if you entertain such a plan. In short, if you are approached by a pension liberation firm, don’t touch them with a ten-foot pole. If you have troublesome debts, seek a different route to sorting them out.

Read more about pension scams.

Unlocking your pension at 55

If you are over 55, your options are much better. If you want to take your tax-free cash now you can – and you don’t have to “retire” – stop work – to get it. You can take the cash and leave the rest of your money invested.

The way pension unlocking works for the over-55s is to transfer your pension into a personal pension plan and immediately take your retirement benefits. (If you are already saving in a personal pension plan, as opposed to an occupational scheme, you are halfway there.) You can do this either by just taking the tax-free cash and leaving the rest of the fund invested or taking the tax-free cash and using the balance of the fund to buy an annuity.

Once you have taken your tax-free cash that’s it, and you can’t have any more when you do actually stop work. The rest of your fund must be used to provide for your retirement.

Read our pension jargon buster.

Don't leave yourself short in retirement

It cannot be emphasised enough that your retirement savings are supposed to be for your retirement, and that by taking your money early you will certainly leave yourself less to live on in later life, and that the amount left may not be enough to give you the lifestyle you would like.

Find out how much money you will need in retirement.

By transferring your existing fund to a personal pension you may lose valuable benefits from the previous scheme you were saving in; if you take your annuity straight away, it may yield a smaller monthly income than it would have done if you had waited a year or two more. There could also be tax implications, particularly as you are still working. If your fund is already small you may incur disproportionate charges on the remaining fund, making your eventual retirement income smaller still.

Pension unlocking is not something to be undertaken lightly, and you need to take independent financial advice on your options. I would probably go so far as to say that, unless you are a fairly sophisticated investor and you have other specific objectives in mind, such as property purchase or tax or inheritance planning issues, or you have severe health problems that could impact on your need for a retirement income, taking your tax-free cash early is best avoided. (There are different rules regarding the pensions of those diagnosed with a terminal illness and a prognosis of less than a year to live and they may be able to take their entire fund as a lump sum. I am however assuming that you do not come into this category.)

Seek professional advice

Before you investigate taking some of your pension early it could be worth your while having a chat with one of the debt advice charities, such as StepChange or Citizens Advice. It is completely confidential, and they may be able to help you find other solutions that allow you to preserve your pension for the purpose you first started to save – to fund your retirement.

You can read more about pensions unlocking and how the pensions liberation fraud works on the website of the Pensions Regulator.   

The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.