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Pensions never used to be considered dangerous. They were regarded as boring, certain and tax efficient. Most employees paid little attention.
The danger — and opportunity — arrived in 2015. pension freedoms were introduced to give over-55s in the UK greater control over their retirement income, but the reforms have had the unwanted side effect of making pensions far more risky and complicated. Fraud is on the rise, and there are now organisations queueing up to sell us “adventurous” schemes.
The old system was simple: you paid into a pension for your whole working life and then had little choice other than to receive a fixed annuity until you died. This model was killed off in part by the historically low annuity rates offered by pension companies and the 2015 reforms. Many scheme members felt they could do better with their money by keeping it invested and drawing down income — a method referred to as “drawdown”.
But with freedoms come responsibility. As you weigh up options for retirement, here are the three key areas to work through:
Is drawdown right for you?
Pension professionals worry that people who opt for drawdown could be subject to high-pressure sales tactics, make mistakes, run out of money or, at the very least, pay more tax than they need to. In the first three years of pension freedoms, HM Revenue & Customs statistics show that almost £17.5bn was withdrawn from UK-based pensions. Last year, 92,000 people transferred money from their final salary pensions to defined contribution schemes.
“In spite of the fact that Pension Freedoms were introduced recklessly fast a few years ago, it is becoming increasingly clear that not only is it extremely popular with investors, it is also working better than many dared to hope,” says Tom McPhail, head of retirement policy at Hargreaves Lansdown. “There is no evidence of widespread losses or poor decision-making on the part of investors.”
The Financial Conduct Authority is about to publish further guidance on how pension providers can help their customers to manage their retirement income.
“People have a lot more to think about with pension freedoms,” Mr McPhail adds. “The impact has been transformative. It has shaped attention to pension savings and retirement in a positive way.”
But not every employer scheme makes it easy to make the right choice. Low annuity rates have encouraged many retirees to consider pension drawdown which keeps the pension fund invested while providing an income, typically of 3.5 per cent of the pension pot. This should maintain the pension fund; on death it should enable the remaining pension pot to be passed on tax efficiently to beneficiaries.
These are attractive features — but as your money will still be invested in the markets, the drawdown method is not without risk.
Some employer schemes do not allow drawdown. They force members to take what they are given or to transfer their pension pots to companies that do allow drawdown, making it difficult for scheme members to liberate their pension pots.
Some schemes are concerned that members could squander their retirement savings or be defrauded by schemes selling totally inappropriate investments. As a result, they have refused members access to their pension pots in any way other than annuities.
While an annuity cannot be reversed, those who choose drawdown can (perhaps when they get into their 70s and 80s) choose to take some or all of their pension pots as an annuity. The interest rates are higher the older we are, and the certainty of income may be more attractive in later life.
Are you on track to retire when you want?
One of the big issues is our ignorance about how much we should put into our pension plans to get the retirement income we need.
Fraudsters and hard sellers have spotted a gap in the market for “pensions advice” that many scheme members experience when they are making decisions about their retirement. Many cold callers have trapped the unwary by promising a “free pension review”. Official pension schemes, guidance bodies and regulated financial advisers are not as proactive as their less reputable counterparts.
There will soon be a “ban” on cold calling by companies which you have no previous business connection with, but it will not have the backing of the criminal law. Cold callers who violate it cannot be arrested. Instead, they will be dealt with under civil law. The only real protection is to put the phone down on anyone who rings out of the blue with advice about pensions and to ignore any emails or direct mailings from companies that you have had no dealings with.
Most of us work for several employers during our working lifetimes and few of us in the private sector have access to generous defined benefit or final-salary pensions. We live in hope that our pension investments will provide enough for the retirement we aspire to.
We retire later, and we live longer. Paying attention to our pension prospects is no longer an academic exercise. No sensible person can ignore how much is in their pension pot and what it will buy in later years.
The Department of Work and Pensions has said that someone on the average UK income of £27,000 should budget for a total income of at least £18,000 in retirement. At current annuity rates for 65-year-olds, this would require a pension pot of about £300,000 — assuming that individual has made sufficient national insurance contributions to get the full state pension of about £8,500 per year. Average pension pots are a lot lower than this even though most of us aspire to a higher retirement income.
Where can you get further advice?
Pension decisions need full consideration and expert advice. The Pensions Advisory Service has provided free guidance in recent years along with Pension Wise, but the government is amalgamating these organisations with the Money Advice Service after autumn 2018. There will still be access to free guidance — but investors should take care when the new body goes live.
When pension freedoms were first introduced, there were a wave of “fake” websites offering guidance set up to persuade people to liberate their pension pots to fraudsters. Some people incurred penalty tax payments of 55 per cent when they withdrew the whole of their pension fund.
An independent financial adviser may charge £500 for an initial review of your pension prospects. A full review can be £1,000 or more if it proves complicated. Be wary of advisers who charge a fee that is a percentage of your pension fund. This can work out much more expensive than a fixed fee.
Understanding the impact of the changing tax rules on pensions should be a key part of any advice you receive. For higher earners, cuts to the lifetime allowance (LTA) governing what can be saved tax free into a pension can cause problems. Those who use pension freedoms to liberate their savings can also fall foul of tax rules and end up with an unexpected bill from HMRC. A pension advice allowance, introduced last year, allows savers to take £500 from their pension pots, tax free, to help pay for advice costs.
Lindsay Cook is co-founder of consumer website MoneyFightClub.com and co-author of “Money Fight Club: Saving Money One Punch at a Time”, published by Harriman House. If you have a problem for the Money Mentor to look into, email firstname.lastname@example.org