Could This Be The Solution To The Pensions Crisis?

If you could withdraw money from your pension early, would it make you more likely to save?

An awful lot of you are seriously anti-pensions. There are many reasons why, but an objection I come across time and time again is people don't like their money being locked away for the long-term. But would it make a difference if you could get your hands on the cash early?

Pension boffins are starting to mull over exactly that and are asking whether allowing some access to cash held in pension funds is the key to getting us all saving more.

My immediate reaction was what a crazy idea -- this will only make the pensions crisis even worse. I've always thought pensions are attractive precisely because there is no access. Personally, I like that there's no option to fritter pension money early once it has been invested.

But now I've had a chance to look the proposals in more detail, I'm beginning to think it might not be such a reckless plan after all.

According to recent research,* 42% of people who already save in a pension would be likely to increase their contributions if some access was allowed. And 42% of people who don't currently save in a pension would consider starting to save if there was an early access option.

But how will it work in practice?

New model

The Pensions Policy Institute (PPI) has come up with four possible pension models which allow early access. These are:

The loans and withdrawal model - this is based on the 401(k) pension system in the US. It enables savers to take loans from their own pension pots, which must be repaid later on with interest. Permanent withdrawals are only available to savers who are suffering financial hardship.

The permanent withdrawals model - this is based on the KiwiSaver model used in New Zealand. Here savers are allowed to make permanent withdrawals from their pension funds with no obligation to repay the money.

The feeder funds model - offers a combination of a pension fund and a savings account. Contributions go into a liquid savings element first. Once a fixed level is reached, future contributions are diverted into a pension fund, while retaining access to the liquid savings.

The early access to lump sums model - this model allows early access to 25% of the pension pot at any age when the pension fund has reached a pre-determined value.

The PPI is currently leaning towards a 401(k) type model (model 1) as the most suitable system for the UK. Two possible proposals have also been put forward for limiting the impact of early access:

• A higher minimum contribution rate for savers whose pension plans offer early access options or,
• A requirement on savers to make a certain level of contributions for a minimum time period before access is allowed.

A mandatory system of repaying loans is likely to be implemented. For example, there may be an automatic deduction of loan repayments from savers' salaries once they earn a specified income level. This would limit the negative impact on low income savers.

How can you spend the money from your pension?

Of course, any system of early access is unlikely to allow savers to squander their pension money on luxury holidays and expensive cars. Instead, there are likely to be limited circumstances when access may be allowed -- such as buying a home or to fund vocational training and higher education costs. Contributions made by employers could help to boost savings more quickly than individual saving schemes outside the pension system.

Access may also be likely to be granted when savers are facing financial hardship, disability/illness and unemployment.

Will it solve the problem?

Studies indicate that allowing early access might encourage savers to contribute more of their income, even if they don't necessarily intend to make withdrawals before retirement. And taking money out of your own pension should be a cheaper way of borrowing than a commercial loan, or a more cost effective way of clearing existing debts.

But it's all a case of making pension saving more attractive, while discouraging excessive and unnecessary withdrawals.

That said for people who are heavily indebted or for whom affordability is a continuing problem, early access is unlikely to be a sufficient incentive.

Will it ever happen?

All pension savers get tax relief on their pension contributions. For basic taxpayers (and non-taxpayers) this means a 20% boost to the money paid into their pensions. So you'll only need to invest £80 out of your own pocket for £100 to be paid into your pension. Higher rate taxpayers, meanwhile, will enjoy a 40% uplift.

Not surprisingly, the government is less than keen on the prospect of savers dipping into money which has already received tax-relief. After all relief is provided so people can save for their retirement, not spend it before that day arrives.

For this reason if a new system is adopted it will probably incorporate tax penalties on money withdrawn but never repaid. And access may never be allowed to contributions made by employers.

Of course, overhauling the pension system comes with a whole range of risks. Pensions will almost certainly become more expensive to run where early access is allowed, and this could lead to higher charges for savers.

But I think the greatest risk of all is that individuals could jeopardise their retirement provision by taking money out of their pensions early. Even if that cash is later replaced there may well be many years of investment growth which can never be recouped.

*British Market Research Bureau, 2008.

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