Last April saw the arrival of the biggest pension changes for a generation. Everyone was granted freedom to access their pension pots from the age of 55. So what have people been choosing to do since then? And are they making the best choices?
Twelve months ago, Chancellor George Osborne lit the blue touch paper and retired to a safe distance… to see how the rest of the nation would choose to retire. Perhaps the result wasn’t as explosive as some feared – certainly, there was no rush to blow entire pension pots on sports cars. The majority of people clearly aren’t so unwise – although one year on from pension freedom, there are signs that they could be wiser. It’s not that they’re making bad choices, but many could be making better ones.
Here’s what the new pension freedom looks like, one year on.
Three and a half billion pounds withdrawn
The latest figures from HMRC show that around 188,000 individuals have accessed their pension pots since last April, taking an average £18,600 in various forms. Totted up, this amounts to nearly £3.5 billion transferred out of pensions into the economy, a figure that exceeds most politicians’ wildest dreams.
The new ways are the most popular
People are flocking to take advantage of the news ways of accessing their pension. Just 13 per cent chose to purchase an annuity, which was previously the most popular (and for many, the only) way of accessing a pension pot. Rather surprisingly, the most popular method (chosen by 34 per cent) was direct withdrawal from the pension pot by a method known (catchily!) as the uncrystallised funds pension lump sum (UFPLS). Meanwhile 30 per cent of people chose to set up a drawdown scheme.
But are they better?
The runaway popularity of the UFPLS and drawdown suggests that some people are acting in haste, without taking proper advice. Both have obvious attractions, but they also come with big potential drawbacks.
The UFPLS method allows you to take a series of lump sums with 25 per cent of each being tax free (as opposed to taking a single tax-free lump sum of 25 per cent of the whole pot). This method may be convenient, but there are downsides too. First of all, the withdrawals are from your existing pension fund, which has been designed to build up your pension pot. This means it may not be structured appropriately for providing you with an income (unlike a drawdown scheme, which should be). Secondly, the fact that this is your existing pension fund means you haven’t shopped around for a better deal, so you could be missing out in that way.
Those people who have chosen drawdown schemes rather than UFPLS are more likely to have a fund that is suitably structured for generating a regular income. However, both drawdown and the UFPLS method share another big potential drawback, which is that a pension pot will be depleted by withdrawals and by poor stock market performance. By contrast, an annuity is less flexible, but provides the security of a guaranteed income for life.
The young want flexibility, the older prefer security
There is a clear age split in the pension choices people are making. Data from the FCA indicates that those aged 65 and over are indeed more likely to buy an annuity, with nearly a third choosing to do so. By contrast, only 16 per cent of those aged 50-59 chose annuities. Drawdown was very popular with this age group (used by 40 per cent) and lump sums even more so, chosen by 44 per cent.
Annuities are making a comeback…
Despite a steep plunge in popularity when pension freedom was introduced, annuities are fighting back. According to the Association of British Insurers (ABI), by the end of 2015 they were actually more popular than drawdown once again, with 21,200 annuities sold compared to 19,700 drawdown schemes.
…and the dash for cash is slowing down
Similarly, the rush to withdraw pensions as lump sums is tailing off, perhaps as people start to reflect on their decisions and the possible implications. Over a billion pounds was withdrawn in case in quarters 2 and 3 of 2015, but by the end of the year withdrawals were down to £660 million.
Pots under £30,000 are generally being taken as lump sums, with the average size being £14,800. However, this can still result in a significant tax bill. For someone with other earnings who is still paying basic rate income tax, a pot this size would lose £2,220 in tax.
Are pensions being used for the right reasons?
The popularity with pension freedom among those under 60 raises some concerns. In the past, most pension pots would have remained untouched until at least age 60 or more often 65. Clearly, the earlier the pots are accessed, the greater the likelihood of them running out too soon (or of not producing a sufficient regular income).
Data from the ABI indicates that 20 per cent of those who accessed their pension pots in the last year did so at least in part to pay off debts. Although eliminating debt is laudable, pensions are primarily designed to provide an income in retirement, so using them as an emergency fund may not be in a saver’s best long-term interests.
The demand for pension advice has skyrocketed
Searches for specialist pension advice on unbiased.co.uk saw a massive increase with the start of pension freedom, and levels have remained high all year. The search (which allows users to specify exactly what they want from a financial adviser), saw a 125 per cent rise in the demand for ‘pension drawdown’ advice, a 116 per cent rise for ‘annuity purchase’ and a 195 per cent rise in searches for ‘pension transfer’. Half of all searches on unbiased.co.uk are now for pension-related advice.
Many tricky choices remain
Whether or not you have started to access your pension using pension freedom, you may well have further choices ahead of you. If you have started to take lump sums, will a drawdown scheme provide better value in the long terms? If you have a drawdown scheme, should you trade some of it in for an annuity? If you’re already considering an annuity, how can you achieve better value?
A financial adviser can help you with all these choices and more. To discuss your retirement needs and how best to use your pension freedom, find your adviser today using our smart postcode search.
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