YOUR MONEY

A comfortable old age is within your grasp – so long as you save hard and don’t misuse the new pension-freedom rules

New pension rules will give retirees more freedom in how they receive their cash

In April we face what chancellor George Osborne has hailed as ‘ the most radical changes to pensions in almost a century’. From the new financial year most pensioners aged 55 and over will have total freedom over how they take an income or a lump sum from their pension – the first time this unfettered access has been granted.

You can take the whole lot in one go – 25 per cent tax-free and the rest taxed as income. Or take up to 25 per cent tax-free and a regular taxable income from the rest, via income drawdown (drawn directly from the pension pot, which remains invested) or via an annuity where you receive a secure income for life.

The big change is ‘freedom’ – being able to draw the whole pension pot in one go. Already cruise operators are reporting a pick-up in bookings.

Good news, then? Only up to a point. The big bet the government is making is that when it comes to decisions about our own financial affairs, the choices we make will be prudent and responsible ones.

Many might agree with the general principle: governments – and fund managers – have certainly no monopoly on financial wisdom. Governments can raid pension pots. Memories of the with-profits endowment policy debacle and the Equitable Life collapse provide another reality check.

And today long-term returns from savings have taken a battering as interest rates stay stubbornly low.

So why not just blow the money? The worry here is that we may be laying the foundations for another pensions crisis: millions may draw down too much at an early stage and turn to

the government for help as penury strikes in later years.

Warnings are already being sounded that the introduction of the new pension freedom is ‘alarmingly chaotic’. Nigel Green, chief executive of Chase deVere, one of the largest independent financial advisory groups, says this major reform is being rushed in to woo the grey vote ahead of the general election.

‘ Only a small fraction of pension providers have confirmed that they will be in a position to offer unlimited access in April,’ he says. ‘It is clear that many pension companies have existing systems that perhaps will struggle to cope with adapting to the new rules.’

Others, he says, might have the required systems in place but will drag their feet because allowing lump-sum withdrawals means a loss of business. ‘ And there is no legislation currently in place requiring pension providers to allow unrestricted access,’ he adds.

Nor do the problems stop there. There are worries that Pension Wise, the governmentbacked guidance service to educate savers on the changes and their impact, will not be properly staffed by the launch on 6 April.

Over the past 15 years the financial services sector has been made to jump through hoops as swathes of new regulations have clamped down on rogue advisers and poor guidance. But now questions are being asked over the level of expertise of those recruited to handle an anticipated initial 300,000 enquiries. ‘ A one-size-fits-all approach to something as important as an individual’s retirement income could result in a host of serious, unintended consequences,’ warns Nigel Green.

There have been plenty of warnings that we are not saving nearly enough for retirement. Many of us seem comfortable that the combination of state pension, private or occupational pension, savings and property will see us through.

And hasn’t auto-enrolment fixed the problem? The contribution rate rises to 8 per cent (made up of 3 per cent employee contribution and 5 per cent employer contribution). Surely this would be enough?

But Jonathan Letham, co-founder of financial education organisation RedSTART, says this would still not be enough for many savers to enjoy a decent retirement.

So how much should we be saving? RedSTART sets out three projections – for minimum wage, living wage and average salary in retirement.

To secure the equivalent of the minimum wage (currently £6.50 an hour or £11,574 after tax) in retirement, we would still need to save £100,000 into a pension pot to generate this in retirement each year – and that’s with the state pension already added in.

Letham calculates that the state pension (currently worth £5,901 a year) and a £100,000 pension pot would generate an annuity income of £10,500 a year – slightly less than the minimum wage.

What of a pension based on the living wage

‘To secure the

equivalent of the minimum wage, we’d need to save £100,000 into a pension pot’

– the amount a person needs to earn to cover the basic cost of living? This currently stands at £7.85 an hour, the equivalent of £13,364 a year after tax.

Here, too, taking into account the state pension of just under £6,000, we would need to save £200,000 to generate a pension of just above the living wage. An annuity purchased with a pension pot of £200,000 would deliver an income of around £9,000 a year, according to Letham’s figures. Added to the state pension, this would give us a figure of £15,000 a year to live on.

Those aiming to secure a pension income equivalent to the average salary (after tax) would need to save enough to generate an income of £23,500. That would require a pension savings pot of £400,000 to secure an annuity income of around £17,500 a year. The state pension would take the total to the average wage.

And how are these savings to be achieved? Well, a 20-year-old would need to save £5,000 a year into a pension, a 30-year-old would need to save £7,000 a year, and a 50-year-old would need to save £10,600 each year.

With such daunting projections having the effect of discouraging us from taking even the first steps on the pensions ladder, little wonder there’s now talk of plans for a second Independent Pensions Commission. The International Longevity Centre calculates that the savings ratio is likely to continue to fall up until 2020, posing a significant risk to longterm retirement incomes. It is set to launch a report on 23 February calling for a second Commission to investigate the prospects for growing personal savings in the UK, the extent to which people are working longer, and continuing increases in life expectancy. The ILC’s Ben Franklin warns that we face ‘a perfect storm of stagnant income growth, low investment returns and a consumption-driven economic recovery. Increasing savings levels is going to be tough.’

Meanwhile, what can we do? Starting pension saving as early as possible can make a huge difference. A useful first step would be to start with small monthly contributions and add to these over the years. The earlier we start, the smaller a percentage of salary we would need to save to achieve our end goal. Just by starting saving at the age of 20 rather than 30 reduces the proportion of salary we need to invest by a third.

Take advantage of all available offers on savings products – even cash being held for emergencies. Savers are missing out on over a billion pounds of interest each year by leaving their money in savings accounts paying the equivalent of 0.5 per cent or less. According to a recent report by the Financial Conduct Authority, the City watchdog, £160 billion is held in accounts where the money earns an interest rate equal to or lower than the Bank of England base rate of 0.5 per cent.

So, while the new freedom around pensions is welcome, it brings tough choices with it – either the luxury cruise, or the home extension or a comfortable annual income. And whichever choice we make, we have a lot of saving to do.

‘People will be able to draw their whole pension pot in one go. Cruise operators are already reporting a pick-up in bookings’