Since April 2015 Pension Freedoms have allowed people aged 55 and over to have far more flexibility with their Defined Contribution pension (for example, personal pensions, stakeholders and SIPPS). It was the most significant pension legislation change for decades.
Recent HMRC data shows that almost 1.8 million people have withdrawn more than £17.4 billion in flexible pension payments since it came in to effect. During the first quarter of 2018 alone, 222,000 people have withdrawn £1.7 billion; a lot of money and an awful lot of people, often needing advice.
Naturally, Pension Freedoms have presented people with significant opportunities, but there are a few downsides to consider also. First, the positive;
1. Early retirement
Gone are the days of picking a date and buying an annuity; flexible income from 55 enables people to retire sooner, only making withdrawals required at the time. Importantly, you then receive continued investment returns on the remaining fund, prolonging its longevity.
2. Moulding your income
Only making withdrawals when required leaves a larger fund and minimises income tax. Of course, you also have the flexibility to withdraw as much as you like for bigger purchases. You need to plan appropriately, but Pension Freedoms give you the ability to mould your income as you see fit.
3. Leaving a legacy
Purchasing an annuity secured an income for life, but when you died (and if you died prematurely) your family wouldn’t typically receive anything from the annuity provider. Some had five year guarantees; for example, if you died two years in to retirement, they would continue to pay income for the remaining three. Others provided a spouse’s pension, but no annuity gave the opportunity to pass a legacy to younger generations. Now, any remaining pension fund is paid directly to the nominated beneficiary when you die.
Increased flexibility also encourages people to save more in Defined Contribution schemes, safe in the knowledge it’s accessible. As pensions are not typically liable to inheritance tax (IHT), this may reduce the potential IHT bill on your estate.
Now, potential issues;
1. Too much, too soon
In 2014 Steve Webb, former Pensions Minister famously said pots can be used to buy Lamborghinis, sparking a big debate on squandering savings. It may feel like a lottery win at 55 (especially if you’ve transferred your Defined Benefit pension), but you must consider the future, as research from Royal London found the average person will need to accumulate £260,000 to enjoy a basic retirement.
Three points to consider;
Realistic life expectancy: Research from Retirement Advantage found that nearly 80% of people over the age of 50 significantly underestimate their lifespan, putting them at a serious risk of an income shortfall.
Hidden costs: As an aging population we are living longer, less healthy lives. The Money Advice Service estimate the average nursing home to cost around £40,000 a year, which would make a serious dent in your pension fund.
Inflation: The FCA have very recently published the final report of its retirement outcomes review, finding that 33% of non-advised drawdown consumers are wholly holding cash. Considering inflation, in real terms, that will have a detrimental effect on the funds purchasing power. Inflation is arguably the biggest ‘hidden’ cost.
Predictable, reliable retirement income is essential. Some annuities are still available, but rates are at an all-time low thanks to the available alternatives. Retirement options are therefore much more complex, and the solution is proper financial planning.
2. Making the wrong decision
Partly attributed to inflated transfer values but enabled by Pension Freedoms, between 1st April 2017 and 31st March 2018 72,700 people transferred out of a Defined Benefit (DB) pensions. The total value was approximately £14.3 billion.
The British Steel Defined Benefit scheme (BSPS) hit the headlines for all the wrong reasons, and the subsequent Work and Pensions Committee enquiry found that members had been exploited for cynical personal gain by dubious financial advisers and represent another major mis-selling scandal.
Unsuitable advice on DB transfers is not confined to BSPS members. Research by the Financial Conduct Authority shows that only half of such advice nationwide meets its standards. Making the wrong decision could be ultimately very costly, missing out on a lifetime of guaranteed DB income.
3. Doing nothing
Hindsight is wonderful thing, but missed opportunities could be as detrimental to pension savings as poor decisions. The only way to mitigate against either is to engage professional financial planners. We will work with our client, helping them plan for the next stage of their life; avoiding the pitfalls and keeping them on track.