The growing pains of pension freedom
First published 06 October 2015 • Updated 25 July 2017
Pension freedom is six months old today. So is it flourishing as we all hoped, or are there still some thorny issues to smooth out? Here’s an update on progress – and some useful insights for you.
We’re half a year into the brave new world of pension reforms – so what do we think of it so far? After the weight of expectation, let’s look at how things are panning out in practice, and what lessons people can learn about the best ways to use their retirement fund.
Number of Lamborghinis bought: approx. zero
In a throwaway line that became the unwanted slogan of pension freedom, Steve Webb (pensions minister at the time) suggested that some pensioners might cash in their pension pots and buy Lamborghinis. It turns out this hasn’t happened – for good reasons. The cheapest new Lambo will set you back £175,000, but you’d need a far bigger pension pot than this to afford one – £250,000 to be precise – because such a big single withdrawal would hit you for £75,000 in tax. And then there’s the insurance…
People are more sensible than they think
How did people plan to use their pension freedom? And what did they actually do with it? A study by pensions firm Zurich suggested that less than 10 per cent of those eligible to access their pension pots had actually done so, whereas 54 per cent said they were yet to make a decision, and 34 per cent were living off other savings first before accessing their pots (in most cases a shrewd move). This is a far cry from all the talk of exotic travel and sports cars we heard back in April. Faced with the reality, people are recognising that this is now their housekeeping money.
But even the wealthy are failing to grasp the tax issues
One would expect high-earners to have a good grasp of tax, seeing as they tend to pay higher rates. Yet figures from the Financial Conduct Authority (FCA) show that to date nearly 140 people have cashed in whole pension pots worth £250,000 or more, presumably taking a huge tax hit on 75 per cent of the total sum. Perhaps these individuals were so wealthy that they didn’t mind losing so much in tax – but that seems uncharacteristic, doesn’t it? A further 47,000 people cashed in whole pots worth up to £30,000, thus potentially losing around £4,500 in tax. That might not sound like much – but it’s nearly a year’s state pension for many people.
Annuities are like Nokia phones
Just as nearly every mobile phone was once a Nokia, so it was that nearly every person who retired used their pension to buy an annuity. But now that annuity purchase is no longer (effectively) compulsory, annuity sales between April and June plunged more than 86 per cent compared to the same time two years ago. People have been swept up in the possibilities of pension freedom, and it’s true that annuity rates have been very disappointing in recent years – but there are already signs that this drop may bounce back – as Nokia phones seem to be doing. The ability of annuities to provide a guaranteed income for life may soon start looking attractive again in an uncertain world.
Business is booming (for fraudsters)
If you haven’t yet had a cold call from someone offering you a free pension assessment or similar, you’re lucky. Countless scams, opportunists and rogue traders have sprung up since pension freedom was announced, often with official-sounding names and perhaps making vague reference to the government or FCA. But don’t be fooled. Legitimate services and advisers do not cold-call you, so you can immediately dismiss it as an attempt to con you out of your money. The same goes for offers of ‘unbeatable investments’ and ‘exclusive offers’. Legitimate financial advisers do offer free pension reviews, but will never contact you first, and any adviser you contact through unbiased.co.uk is fully regulated by the FCA.
Are we suffering from reform fatigue… or just common sense?
Yet another proposal to reform pensions, by making them work more like ISAs, has met with a decidedly lukewarm response from providers, advisers and pundits alike. At first the general public seemed to love the idea of getting tax-free withdrawals at retirement age – forgetting that this would mean losing the far more valuable up-front tax relief we have at the moment. It just goes to show: what at first looks like a brilliant deal, often isn’t.
We want freedom to be free
City watchdogs have revealed that as many as one in 10 savers will have to pay exit fees to access their pension pots, with a small minority hit by an eye-watering 40 per cent charge if they want full freedom. The government is coming under pressure to ban exit fees, as around 1.5 million of those potentially affected are under 55 and yet to access their pensions.
But compulsory advice isn’t a bad thing
Exit fees shouldn’t be confused with those providers who insist that savers pay for independent financial advice before accessing their pensions. This is often the case where someone wants to transfer a final salary scheme into a defined contribution scheme, trading in guaranteed lifelong benefits for a single lump sum. As this is such a major decision, even for small pensions, making it compulsory to seek advice is a sensible safeguard to protect people’s long-term interests.
Questions have been raised by those who have already bought annuities, and who feel they have ‘missed out’ on pension freedom. Some want to know if they can cash in their existing annuities – and as things stand the answer is no. There has been talk of a future market in second-hand annuities, allowing people to sell them on for a lump sum, but nothing is confirmed yet. What does seem probable is that no annuity would sell for anywhere near its original purchase cost, so this would not be recommended in most circumstances.
Still confused by pension freedom? There’s no need to be. Book an appointment with a financial adviser near you and talk through your concerns.