The Daily Telegraph - Money
The 25pc tax-free lump sum is pensions’ greatest selling point. But its very appeal encourages us to forget about the other 75pc
I have spent many years and column inches trying to explain the inner workings of Britain’s pensions system and I’m afraid only one fact really sticks in the minds of most people: that you can take a quarter of your pot entirely tax free.
The lump sum is one of pensions’ greatest selling points. But this gives rise to a problem: we forget about the other three quarters.
In times gone by this didn’t matter. You either had a defined benefit pension and, after you took a lump sum, got a guaranteed income for life, or used a defined contribution or “money purchase” fund to buy an annuity with the remaining 75pc to achieve the same end. But since April 2015 and the pension freedom reforms, annuities have gone the way of the dodo. So when most people reach 55, the age at which you can access a private pension, they have to manage it themselves.
A very handy feature of the new flexibility is that you can take just the tax-free lump sum and leave the rest invested. There are several reasons why this tactic is useful.
For a start, taking only the lump sum means you keep the £40,000-a-year limit on pension contributions. Take more and the annual allowance plunges to just £4,000. If you take your lump sum at 55 you may not fully retire for another decade or two, during which time you will want to maximise your pension savings, so it is crucial not to accidentally trigger the lower allowance.
Second, leaving 75pc of your pension invested in the place where you built it up, usually a workplace pension, means it is protected by lower charges and strict rules.
The problem is that it appears most people are cashing in their entire pension to get hold of the lump sum and then leaving the remainder either in an expensive “drawdown” account or, worse still, in a standard bank account or cash Isa, even if they don’t intend to use the money for decades.
Both these scenarios have dire consequences for people’s ability to fund themselves through retirement, Sir
Steve Webb, a former pensions minister, has warned. Now a partner at the consultancy LCP, Sir Steve is calling for a rule change that would let savers take their lump sum and leave the remainder in their company pension fund. This would stop the higher charges on drawdown accounts and the nonexistent returns offered by savings accounts slowly eroding the value of pensions that need to last for 20 or 30 years.
LCP calculated that a basic-rate taxpayer who cashed in a £20,000 pension would be £5,500 worse off after 10 years if the pension were left in a cash account rather than in a shares-andbonds portfolio in a low-cost pension.
To its credit, the pension industry has become very good at helping people build up their savings. Fees are now low and most schemes are overseen by trustees, who have a legal duty to act in savers’ interests. But the regulatory environment when you retire and enter what the industry calls the “decumulation” phase is still a Wild West.
My advice is to be wary of “default” options presented to you, know how much you are being charged and for God’s sake don’t take money out of a pension until you need it.
The pension industry helps you save but once you want to withdraw money it’s a Wild West