The introduction of pensions freedom in April 2015 abolished the compulsory purchase on an annuity, and members of defined contribution pension schemes over the age of 55 can now cash in their pensions pot early and use the money in whatever way they wish. However, some schemes levy substantial charges for an early exit.

Early exit charges were common on pensions started in the 1970s, 1980s and 1990s, and can be as high as 30%, although charges of 2% to 5% are more typical. Such charges are substantially more than the cost to the supplier of an early exit, and present a barrier to the exercise of pension freedom. They are also a barrier which prevents members from transferring their pension pot to another scheme. Therefore this cap is a welcome move which limits the extent to which defined contribution schemes can rip off their customers.

This cap on early exit fees only applies to contract-based defined contribution schemes, and does not apply to trust-based defined contribution schemes who are regulated by the Pensions Regulator (tPR), not the FCA. However tPR intends to impose a similar cap on the early exit fees of trust-based defined contribution schemes as from October 2017. From April 2017 there will also be a 0% cap on early exit fees for new contract-based defined contribution schemes.

While cashing in their pension pot will become more attractive to those currently facing a large early exit fee, members should exercise caution. The value of any pension that is cashed-in is added to the member’s income that year, and this can easily lead to a substantial income tax charge.

By Professor Charles Sutcliffe