From the Money Telegraph, 21 Sept:
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Unlock your pension at your peril
(Filed: 21/09/2005)

A lump sum on retirement sounds attractive, but it could cost you dear,
warns Teresa Hunter

Pension experts are warning that many employees are being short-changed by
£6 billion a year when they take a tax-free lump sum from their pension on
retirement.

Beware of raiding your pension piggy bank by taking a lump sum

These cash sums - typically equivalent to 18 months' salary - are often used
to fund a cruise, buy a holiday home or build a conservatory.

The problem particularly affects those working in the private sector who are
members of a final salary pension scheme. In order to take a tax-free lump
sum, employees have to take a cut in the pension they receive in retirement.
But many people don't realise that what they give up in pension benefits is
worth far more than the cash sum they receive, even allowing for the fact
that it is a tax-free payment.

Rules differ from scheme to scheme, but in most final salary schemes you get
between £10 and £12 cash for every £1 of pension you forgo. This may not
sound like too bad a deal. But if you tried to replace this income by
purchasing an annuity, you would need a cash sum worth twice this amount.

For example, a man aged 65 would pay about £25 to "buy" £1 of pension
income. Those retiring younger and women, would pay even more.

John Lawson, the marketing manager at Standard Life, says: "Some years ago
it made sense to always take tax-free cash because it offered fair value,
but today it is a very bad deal. Yet most people still opt to take this
cash."

Over the past decade or so life expectancy has increased significantly,
which has contributed to annuity rates falling. But few pension schemes have
adjusted the rates at which they calculate the "cost" of these lump sums.

Many trustees still use actuarial calculations that haven't changed for
years - which is why today these lump sums represent such poor value.

Insurance companies are urging those affected to lobby their employers and
pension trustees for a better deal. Lawson says: "Those approaching
retirement should wake up to the problem and begin asking for a fairer deal.
As it stands, they are being seriously short-changed. I am very surprised
that this issue has not been taken up by the unions."

Collectively pension schemes are saving themselves about £6bn a year, Lawson
estimates, from those who opt for the tax-free lump sum.

Of course, regardless of the financial disadvantages, it is easy to
understand why taking a lump sum from your pension remains popular. Stewart
Ritchie, the pensions director at Aegon, says: "Everyone dreams of coming
into some money, but for most people taking cash from their pension is the
only time in their lives when they will have a big lump sum to spend."

For some this money may be desperately needed - perhaps to pay off a
mortgage or other debts. Others will undoubtedly prefer to have cash in hand
rather than gamble on living long enough to get this back through higher
pension payments - regardless of the financial "cost" of this deal.

Ritchie adds that it is also important to consider your tax position. Any
income you receive as a pension is taxed at your marginal rate. He says: "If
you are going to be a higher-rate taxpayer when you retire, then it is
closer to call. These tax-free lump sums do not represent such a bad deal.
But if you pay standard tax or expect to pay no tax after retirement, then
the cash is not providing particularly good value."

Lawson says this problem looks set to get worse from next April because
changes to pensions rules will allow employees not only to take a lump sum
from their pension scheme of up to three times annual salary, but also they
will be able to take it from the age of 50 without retiring. The worry is
that people will empty their pension funds at the earliest opportunity,
leaving little for old age.

Given that many final salary pension schemes have big holes in their
finances, some trustees will encourage staff to take the maximum lump sum
possible, effectively allowing the pension scheme to off-load its
liabilities cheaply.

Lawson adds: "Some pension schemes may not be happy with employees taking
this money. But why wouldn't they want you to take the maximum cash you
can?"

Indeed, evidence suggests that a number of actuaries are suggesting this
option to trustees as a legitimate way of reducing pension fund deficits.

Those with a money purchase pension scheme will also be able to take a
larger tax-free cash sum - although they will not be as disadvantaged as
those in a final salary arrangement. This is because their pension depends
on the size of the fund and prevailing annuity rates rather than their
salary.

So if an employee has built up a £100,000 fund and takes out a £25,000 lump
sum, he simply has £75,000 left with which to buy an annuity. This still
means a smaller pension income in retirement, but at least workers will get
a "fair return" on the money they take out of their pension fund.

The worry is that investment growth has been poor in many of these company
pension schemes and with workers suddenly able to take out three times their
salary, this will leave little to provide their pension income.

Those working in the public sector, who generally also have final salary
pensions, are unlikely to be affected by this problem. This is because
teachers, nurses, civil servants and local authority workers receive a cash
lump sum on top of their promised salary-related pension.