The City watchdog has warned consumers they could reduce their retirement income by more than 50 per cent if they cash in their pension pot before they retire.

The Financial Services Authority (FSA) has issued a consumer alert warning people of the pitfalls of so-called pensions unlocking schemes.

Pensions unlocking allows someone who is over 50 to release money from an occupational or private pension before they reach retirement age.

Pensions benefits are transferred to a new pension, 25 per cent of which can be taken as a lump sum, with the rest used to buy an annuity to provide a retirement income either straight away or when the holder is 65.

But the FSA warned a man who unlocked his pension 12 years before he was due to retire could see his income cut by more than 80 per cent, while on average benefits are reduced by up to 50 per cent.

A 53-year-old man who had a pension fund with a transfer value of £11,256 and took a cash-free lump sum, could see his annual income reduced to £340 a year if he bought an annuity at 65 under one of the unlocking schemes, compared with £1,824 a year if he had left the money in his original pension.

David Kenmir, director of investment firms at the FSA, said: "Releasing cash may sound very tempting but you need to stop and think about whether you really need to do it.

"It is rarely in anyone's long-term financial interests.

"Only in exceptional cases, where you have immediate needs and no other option, should you even consider it.

"There are likely to be better ways to address any short-term cash needs so think very carefully."

The regulator is urging consumers to ask themselves how much money they need and whether they would be better off borrowing the sum or cashing in other investments before unlocking their pension funds.

The FSA said it was looking at firms engaged in pensions unlocking and would take action if it thought consumers had been given inappropriate advice or firms had run misleading promotions.