Reducing pension contributions during the cost-of-living crisis could have “hidden risks” for savers, LCP has said, suggesting that using pensions to help with short-term spending pressures should be “an absolute last resort”.

The consultancy warned that, as energy bills increase, growing numbers of over 55-year-olds may be thinking of tapping into their pension savings to tide them over.

However, LCP highlighted a number of “hidden risks” that could impact savers looking to withdraw their pension savings, pointing out that accessing pensions now can make it much harder to build pension savings back up in future as the annual limit for tax privileged pension saving could fall by 90 per cent.

It explained that while people can save £40,000 per year into a pension and enjoy the benefits of pension tax relief, those who flexibly access a DC pension pot worth over £10,000 can trigger the Money Purchase Annual Allowance, reducing their annual limit to £4,000.

In light of this, LCP warned that, if energy prices fall back down and the economy emerges from recession, those who have dipped into their pension may find they cannot take advantage of the upturn.

In addition to this, the consultancy pointed out that withdrawing the first lump sum from a pension pot can trigger income tax at an “emergency” rate.

Under HMRC rules, the pension provider has to deduct tax at a penal “emergency rate”, as if the saver was going to make multiple withdrawals over the year and, although the excess tax can be reclaimed, it means the saver may get less immediate tax from their withdrawal as they hope, LCP explained.

Savers were also encouraged to be mindful of the potential impact on other benefits, as LCP warned that leaving a balance in a bank or savings account could see a deduction in any benefits that savers receive, and, in extreme cases, could lead to savers being disqualified from benefit altogether.

LCP partner, Steve Webb, commented: “It is entirely understandable that people under severe financial pressure may consider tapping into their pension savings to help pay the bills. But they need to be aware that there are hidden risks in doing so.

“Those who use ‘pension freedoms’ legislation to take taxable cash in a lump from their pension could trigger a much-reduced annual allowance which will make it harder to rebuild their pension in the future.

"Those on benefit could find that their benefit is reduced or stopped if they leave a lump sum in their bank account. And HMRC will often apply ‘emergency tax’ to withdrawals, leaving savers with less than they expected.

"Coming on top of the impact on standards of living in retirement, these hidden risks provide additional reasons to regard using pensions to help with short-term spending pressures as an absolute last resort.”

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