Pensions freedoms, introduced in 2015, allows over 55s to access their retirement funds. LCP said a trend had emerged where people encash their pension pots only to shift the money into cash ISAs or other low interest accounts meaning they lose out on potential investment returns.
LCP suggested the problem could be tackled by allowing people aged 55 and over to access their tax-free lump sum while leaving the rest of the fund invested.
LCP looked at official figures from the Financial Conduct Authority (FCA), which showed that, between April 2015 and March 2020, a little over 1.7m people took their full pension pot out in cash. More detailed data for the period 2018-2020 suggested that the average fully encashed pot was worth about £12,500.
The regulator's Retirement Outcomes Review, released in 2017, revealed 32% of people who had encashed pots put the money into an ISA, savings or current account. LCP said the majority of these would be cash accounts (as opposed to stocks and shares ISAs), as the FCA identified a separate category of 20% who invested the largest share in ‘capital growth'.
The consultant then applied the 32% figure to the 1.7m who have taken cash out in full. It estimated 555,000 people took cash from a pension and put it in a cash account or similar earning rates of 0.5% or lower.
It added, by contrast, money left in a pension and invested in a mix of stocks and bonds would yield an expected return of 4.4% based on official assumptions.
"Moving money from a pension into a cash ISA or similar product could therefore produce a loss in returns of around 3.9% per year," said LCP.
"Based purely on these assumptions and official data cited above, we estimate that just over half a million people who have taken their pension pot in full since 2015 and put the money in a cash account will suffer a collective loss in returns of £2bn, assuming that they do not take action to move the money to somewhere where it will generate better returns. This is based on 555,000 people losing an average of £3,500 each."
LCP partner and head of defined contribution Laura Myers said: "Savers who withdraw their entire pension pot and move most of it into a cash account are at risk of seriously damaging their wealth.
"Interest rates on cash accounts are currently well below the rate of inflation, meaning money left in such accounts for the long-term will steadily erode in value. The attraction of tax-free cash is well understood but it should be much easier for savers to leave the rest of their money behind inside the pension where it will continue to be invested for growth until they need it."
Former pensions minister and LCP partner Steve Webb added: "Putting money in a cash account can seem safe, but the only thing that is guaranteed at the moment is that you will see your spending power decline year after year.
"For those who have already used their freedom to take their pension pot in full, more needs to be done to alert them to the real losses they will suffer if they simply park their savings in a cash account.
"And we need to ‘de-couple' the act of accessing tax-free cash from accessing the rest of your pension. Unless things change, hundreds of thousands more people could find they are not making the best use of their hard-earned savings."
Source: Professional Advisor