Your Pension – Don’t Kill the Goose!
First published 13 January 2016 • Updated 25 July 2017
A decision on your pension can take only a moment, but you might have three decades to regret it. New market figures suggest that many people just aren’t giving this process the necessary attention, and could be damaging their retirement prospects. Your pension is important – so handle with care.
Everyone knows the story of the goose that laid golden eggs. The farmer was so greedy for more gold that he cut the goose open to get at the rest. A financial adviser could have warned him off (but may have been busy securing a mortgage for the third Little Pig).
Today we don’t have that farmer’s excuse, financial advice being more widely available. But recent data gathered by the Financial Conduct Authority (FCA) reveals how people have been accessing their pensions in the months since they were granted full access to their pots. It looks as if a lot of people still haven’t learned the lesson of the farmer and his goose. Here’s how to avoid making their mistakes.
Cooking your goose (4 blunders to avoid)
- The poorly-planned lump sum
Pension freedom made it possible to access the whole of a pension pot as a lump sum from the age of 55. Huge volumes have been written (not just on these pages) about why this is generally a bad move. So what did most people do last summer? Over 120,000 pension pots – 68 per cent of all those accessed between July and September 2015 – were entirely cashed in. So the choice made by most people is the one that advisers generally agree to be the worst decision of all.
True, most of the pensions (88 per cent) were worth £30,000 or less, so many may not have been that individual’s only pension. Still, drawing out £30k all at once while also receiving the full State Pension could land you with a tax bill of over £3,500 – more than 10 per cent of your pension pot.
Some people have been even more incautious, cashing in pots of £250,000 and over. Of the people who did this, one in five neither sought advice or even consulted Pension Wise. With such a large pot, much of it would be subject to higher-rate and additional-rate tax, resulting in a big chunk of it being lost.
Always make sure you fully understand the tax implications of any pension withdrawal you make, remembering to factor in any other income you may have (including from the State Pension, which is taxable).
- Rushing into drawdown
People opting for drawdown (leaving your pension invested to generate an income) are the most aware of the need for advice. Nearly 60 per cent of those who chose drawdown did so with the help of a professional adviser. However, that leaves over 40 per cent who set up a drawdown scheme without advice. You might have thought that people would make use of the government’s free guidance service instead, but just 17 per cent of drawdown customers used Pension Wise before making their decision.
With drawdown, there is always the possibility that your fund will run out before the end of your life. Another risk is that the money is still exposed to the stock market, so can go down as well as up. Given the current volatility of the market, entering drawdown without taking professional advice is a very risky move.
- Don’t dismiss the annuity
Rumours that annuities are no longer good value are largely unfounded. What is true is that you’re unlikely to get the best value if you just take the first annuity you’re offered.
Research from the International Longevity Centre (ILC-UK) suggests that people still want the very thing that annuities offer: a guaranteed income for life. When the question was phrased in that way, 70 per cent of respondents were in favour. This is in stark contrast with the FCA’s summer figures, which reveal that only 13 per cent of pension pots were used to buy an annuity.
More research from the FCA suggests that 80 per cent of people who bought annuities could have got a better deal by shopping around on the open market. Many people are also unaware of the factors that can boost your annuity levels (how much income you receive) such as health, lifestyle or even where you live.
- Beware the ‘mis-buying’ scandal
We hear a lot about mis-selling scandals – providers selling people products that are inappropriate for them. Unfortunately, as consumer we’re just as good at finding those unsuitable products for ourselves – and if we do, we have no-one else to blame. Pension freedom is the ultimate case of ‘buyer beware’.
The IFA’s data shows that the biggest withdrawal from pension pots was among the 55-59 age group. This is a worrying finding, and raises the question of whether these people will have enough money left to fund their retirement. Also, they may not realise that by accessing their pension pots, they limit their future contributions into the pot to just £10,000 a year.
Arguably the most significant finding was the fact that people still aren’t shopping around for retirement products. Of those who chose drawdown, 58 per cent stayed with their existing provider, while 64 per cent of those who chose annuities also stayed put. Matthew Harris of Dalbeath Financial Planning estimates that staying with your current provider only delivers best value around 5 per cent of the time.
Pension freedom may be here, but many people still aren’t using the freedom they already had: the ability to shop around for the best deals.
Pensions were always complicated – now they are more so than ever. Seeking professional advice on your options is the best way to help your retirement plans to achieve a fairytale ending. Find your adviser here.