Could Pensions Be A Future Short-Term Finance Option?
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Could pensions be a future short-term finance option?

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With banks unwilling to lend and credit unions still too narrow in their scope to provide a widespread leaning alternative, investment and pensions firm Hargreaves Lansdown says emergency cash from pensions could be used to plug this gap.

In recent years the payday loan industry has boomed as a result of the lending gap. The service provided by lenders like Wonga is quick, convenient and easy to use, and allows those who might struggle to access credit elsewhere to source the short-term finance they need. In 2012, 10 million payday loans were taken out and this trend is set to continue, particularly with the proposed cost caps which will limit the cost of a £100 loan over a 30 day period to a maximum of £124.

However, Hargreaves Lansdown believes savers should be entitled to access their pensions before retirement age to reduce the need for short-term lending. It affects your retirement prospects.

Early access to pensions

short-term finance option

A recent investigation by the Competition and Markets Authority found that nearly half of those who had taken out some form of short-term loan had done so to meet an unexpected increase in their expenditure. While the majority were happy with the service they had received from the payday lenders, a small cash reserve incorporated into an individual’s pension pot would help to avoid the requirement for credit.

Hargreaves Lansdown proposes that each household should be offered a small cash reserve of several hundred pounds from their pension fund to access in an emergency. These would mean unforeseen increases in expenditure could be met without the requirement for a short-term loan.

As a result of new pensions regulations which force every employer to enrol workers on a company pension scheme, millions of workers could build a potential cash pot reserve in as little as two years, which could then access in an emergency.

The impact of this small cash pot on the overall value of workers’ pensions would be minimal, and depending on the individual pension structure, it could account for as little as two percent of the pension’s value.

To ensure the cash pot is used only for emergencies, the firm suggests pension holders should be required to consult The Pensions Advice Service before they are allowed to draw on their cash. They would only be permitted to withdraw cash once they have paid into their pension for a number of years.

How the scheme would work

Hargreaves Lansdown has produced a paper which outlines three potential ways the scheme might work. This includes:

  • Employer contributions are skimmed over a relatively short period of time to build the cash pot. Once the cash pot is full, the contributions can then be redirected back into the main pension fund.
  • The Government tax relief workers’ pension contributions attract could be diverted into a cash account for a number of years to build the emergency pot, before being redirected back into the pension fund.
  • As an alternative to a separate cash pot, a loan option could be added to the pension by the provider which allows pension holders to borrow a capped sum from their pension fund.

In practice, these proposals seem watertight. In all of the schemes suggested above, government, employer and employee contribution levels would remain at their current levels. In the first two schemes there would be an opt-in clause for employees to sign. In the final proposal there would be no requirement to opt-in.

If the proposals came into a force, in just two yeas an employee earning £20,000 could build an emergency cash pot of £1,225 by redirecting their employer’s contributions, while redirecting the tax relief over a four year period would create a fund worth £833.    

Tom McPhail, head of pensions research at Hargreaves Lansdown, said: “For many people, simply having a cash reserve of a few hundred pounds to draw on in an emergency would be a huge step forwards in strengthening the country’s financial resilience. It could be achieved at no extra cost to the savers, and with minimal disruption to the pensions system.”

Are there any potential drawbacks to this proposed scheme? Would you choose to opt-in if such a scheme did exist? We’d love to hear your views about these proposals, so please leave your thoughts in the comments section below.