One of the main barriers to people starting a pension is the fact that their money will be locked away until they retire – which can seem unimaginably far in the future, especially in your 20s or 30s.
The ability to cash out your pension early can help to assuage this anxiety, although financial advisers caution against an early drawdown of pension funds, warning that it may severely impact income in older age. Policymakers also discourage it.
Yet growing inflation is seeing people begin to reassess their financial position and surging house prices, education costs and other lifestyle needs may mean that sometimes funds are needed, and fast.
“Given the increases in the cost of living and borrowing rates, we are seeing more clients look to access funds before their normal retirement age,” says Gavin Moran, head of the wealth management division at WTW in Ireland.
A similar trend was observed following the 2008 financial crash and conditions on early drawdown were relaxed in many countries. In Ireland the Government temporarily altered its policy to allow those who had topped up their pension fund via additional voluntary contributions access that portion of their pension fund early.
But while immediate access to cash can be alluring, Moran points out that the short-term vista is very different from the long-term one.
“While it is very tempting for clients to have these funds available, we would always caution that it is also important to think of your future self in retirement as these funds will possibly become even more valuable to you when you are no longer earning,” he says.
“Your pension fund is the only asset that can grow tax-free, and whilst you will get an element of it as a tax-free lump sum, the income drawdown will be subject to PAYE and associated levies,” explains Suzanne Cashin, divisional director in financial planning with RBC Brewin Dolphin.
“Of course, growth is not guaranteed but we would always encourage people to defer retirement as long as they can. Pensions are a long-term investment and the longer you can defer the drawdown the better the outcome for your long-term retirement income.”
Early drawdown is possible with all pension products, although Cashin says some may have a penalty or charge.
Moran points out that when you can access funds varies between pension products.
“With an occupational pension or personal retirement bond you can access it from age 50 at the earliest but you will have to have left the employment of the company to which that particular pension relates,” he explains.
A personal pension can be accessed by the age of 60, as can a personal retirement savings account.
He notes there has been a small change to Revenue practice this year: “You can now access the fund between the ages of 50 and 60 provided you cease all employment and self-employment – you must effectively retire from everything.”
According to Cashin, if someone has a large pension fund early drawdown will not have the same impact.
“In some instances, subject to pensions rules and the Revenue handbook, it may be possible to early retire a pension plan in your 50s, access your tax-free lump sum and not have to take a drawdown from your ARF [approved retirement fund] until you hit age 61,” she says.
“The ARF continues to benefit from tax-free growth up to age 61 – in most instances if your ARF is invested in a good, diversified portfolio over a 10-year period you could expect the fund to go back to at least the value it was before you accessed your tax-free lump sum.”
For those considering early drawdown, solid financial advice – including modelling for the future – is warranted.
“Our advice would be to use up your cash reserves, mindful of keeping ideally at least six months’ essential expenditure in your emergency fund,” says Cashin. “Then look at whether it makes sense to liquidate other investments or property, where you may be paying capital gains tax as opposed to income tax.
“Clients often do not understand the implications of early drawdown on your ultimate retirement and this also increases the risk that you run out of capital in retirement.”