What if you were allowed to unlock your pension?

IN THEORY, IF you’re in financial straits unlocking your pension fund can appear to make a lot of sense. After all, if you’re struggling to make ends meet now, having thousands locked away in a pension fund is probably not going to offer you much comfort. But is that reason enough to unlock your future to save your present? While there is growing momentum behind an initiative to allow people do just that, there are plenty of pitfalls to this approach.

THE CASE FOR UNLOCKING

If you’re struggling to meet your mortgage repayments, pay down your credit card debt or just meet the daily cost of living, what good is your pension fund doing you? If it can help you keep the bank off your back and allow your family to remain in your home, then there may be an argument for doing so.

“On the face of it, if people are struggling with borrowings, then there is a case to allow people access savings that are locked away,” says Aisling Kennedy, client director with pensions specialist Mercer.

Ian Mitchell, director of pensions with Deloitte, agrees. “If someone needs cash now, then it could be advantageous to have that cash. There could be a strong argument for someone in heavy debt.” At present, you can only access your pension funds if you have been in the fund for less than two years, or when you reach the age of 50 and take early retirement. Any amendment to this would require legislative change.

Linda Gallagher, a member of the Irish Brokers’ Association’s pensions committee and managing director of First Ireland Risk Management, says there is considerable demand for such an initiative.

“We’re meeting clients every day who have a lot of short-term expensive credit card debt but have €80,000-€90,000 locked away in a pension fund,” she says, while Kennedy adds: “We do have people writing to pension fund scheme trustees to see if they can access funds.”

While Gallagher is keen to point out that “it’s not a panacea to everyone’s ills”, she thinks that the benefits of using pension money to pay down debt now could outweigh the cost of keeping these funds locked away for retirement.

“If you’re mounting up credit card charges, the additional interest cost on the credit card may be far in excess of any benefit you might get,” she says.

Gallagher would like to see people being able to take 25 per cent of their pension fund as a tax-free lump sum at times other than just retirement. “There could be a lifetime limit,” she says, adding that you could just avail of the tax-free option once.

And while the option of using the Personal Insolvency Bill (PIB) to wipe out credit card loans of up to €20,000 will soon be an option for those struggling, Gallagher says that many would prefer not to opt for this. “It will affect your credit rating if you go down that route. Irish people are very proud and would see the PIB as a last resort,” she says.

It could also be argued that by making pensions more flexible, they could become more attractive.

“If you’re 30 then 65 seems like forever away. If people knew that in certain circumstances that they could tap into that fund, then it could encourage people to save more,” says Kennedy. Indeed Mitchell suggests that there might be a case to be made for introducing something along the lines of the 401K system in the US, which allows withdrawals at certain points.

“It would be a complicated product for anyone to design but it’s been done in the States. It’s not beyond the scope of any company and at least people would feel that their long-term and short-term needs were being met,” he says.

THE CASE AGAINST

For most pension experts, the crux of the issue is that it’s hard enough to save sufficient money to support you for potentially 30 years at the best of times; never mind reducing it by deducting money from it before retirement.

Moreover, allowing access to pension funds early goes against one of the tenets of the product – that it is designed to be untouched until retirement.

“The reason why they’re [funds in a pension] normally not allowed to be withdrawn is to ring-fence them for retirement provision. That’s a very strong principle. If you allow that principle to be changed in one context, it could be very, very difficult to maintain it in the wider sense in the long run,” warns Kennedy. As such, Kennedy argues that “on balance, early access is counter-productive”.

“We would be of the view that if you were to allow this then it would have to be very carefully thought through, with proper controls and constraints,” she adds.

There is also the issue of how much damage you will do to the amount of money you will have to live on when you retire. Arguing that you can rely on the State pension is not likely to carry much weight in 30 or 40 years’ time, when such a payment might no longer exist or might be worth considerably less.

“You get 25 per cent of the pot tax-free when you retire – you only have one bite at it. If you take it early you won’t be getting as much tax-free money so the pot won’t be as big. You’ll be penalising yourself long-term,” says Mitchell.

And taking out money now, without replacing it in a hurry, could be a big penalty to pay. Take the example of a 40-year-old with a €100,000 pension fund, built up through a combination of personal and employer contributions. Even if this fund received no further contributions, by the time that person was ready to retire, at the age of 66, the fund would be worth €217,934, assuming an annual return of 3 per cent – which would, at the very least, offer a welcome top-up.

Or how about a fund worth €40,000? On a similar timescale this could be worth over €87,000 by the time of retirement.

In this regard, Kennedy recommends that people should see a projection of how long it would take and how much they would need to contribute to restore their fund to its previous position, before making any decision.

Of concern also is whether or not lenders might “persuade” people to release their retirement funds now, to pay off current debts. “Banks could see this as easy money,” notes Gallagher, while Kennedy adds: “There is a difference between someone freely making this decision and being pushed into it by a lender.”

While Minister for Finance Michael Noonan has said that he could be “open” to updating legislation to allow people to unlock their pensions early, last year the Government’s Economic Management Council considered the issue but found against it. Part of the reason was due to the fact that those suffering the most at present might be unlikely to have saved enough in their pension funds in the first place – and even if they had done, given the direction of markets over the past few years, there might not be enough in the fund to help resolve their financial problems.

And it might be wise to consider the experience of the UK, where some pension schemes pioneered a type of “pension unlocking” strategy last year, whereby the individual would effectively borrow money from their pension fund. The regulator, the Financial Services Authority, came out with a strong warning against this.

“Early access to pensions is rarely in anyone’s long-term financial interests,” it said, warning that “unlocking your pension can mean money today, misery tomorrow”.

You get 25 per cent of the pot tax-free when you retire. If you take it early you won’t be getting as much tax-free money so the pot won’t be as big