Countdown to freedom
In a special four-page report, we highlight the benefits – and the pitfalls – of pension reform
DON’T ACT IN HASTE
EVEN though the new pension freedoms do not kick in until Easter Monday – the start of the new tax year – some companies are intent on persuading people to release cash from their pensions. This is irrespective of whether it makes sound financial sense.
Daytime TV channels are already carrying adverts from financial companies keen to help people aged 55 and over unlock their pensions.
Although these companies are not acting illegally, most people should not be tempted, especially those in their mid-50s or early 60s who are still working or yet to put themselves in a financial position where retirement is a viable possibility.
Indeed, by accessing their funds early, they may inhibit their ability to make future contributions into their pension pot.
Fiona Tait, pensions specialist at financial services group Royal London, says: ‘I am concerned that some people will take too much from their plans, simply because they can under the new rules.’
She says similar pension freedoms have been available in Australia for more than 20 years. Experience there suggests that although most pensioners don’t cash in and spend their whole pension in one go, many do run out of money.
Tait believes most people would be far better off using April 6 as a trigger to take stock of all their longterm savings plans.
She says: ‘Most people are unlikely to be fully or even partially retiring at age 55. So rather than cashing in, they should set targets for their retirement – looking at how much income they will need to retire on, whether their investments are set up to deliver the returns they need, and whether their hotchpotch of pensions and investments need to be consolidated to deliver better value for money.’
DON’T FORGET TAX
ALTHOUGH everyone is entitled to tax-free cash from their pension – usually restricted to a quarter of a pension pot’s value – with- drawals above this level will attract income tax. It will be levied in the tax year in which the withdrawal is made and charged at a person’s highest marginal rate of tax.
Tait says: ‘At age 55, most people will now have the equivalent of an instant-access pension account. But, no matter in what form they withdraw money – in one lump sum, through the purchase of an annuity or by drawing down income as and when they choose – it will be taxed.’
She says that as a result, savers must consider not just the amount withdrawn but also the rate at which money is taken. The greater the rate at which they take their money and spend it, the greater the rate of tax that is likely to be due.
DON’T CASH IN DEFINED BENEFITS
MANY employers will view the new pension freedoms as an opportunity to reduce the cost of running expensive defined benefit pension schemes. They will do this by encouraging employees or former workers to transfer out – with the promise of a cash sum.
Most people should not be tempted by such offers because defined benefit pensions – often known as final salary schemes – remain the most deluxe of arrangements outside of the public sector.
The pension paid at retirement is based on two prime factors – length of scheme membership and the salary at retirement. In nearly all circumstances, bar an employer going out of business, the pension
promised is the pension paid. So members do not have to worry that their pension pot could be decimated by a stock market correction prior to retirement. Bruce Moss, strategy director of eValue Investment Solutions, a provider of financial planning tools to advisers and consumers, says members of defined benefit company pension schemes should stand firm.
He says: ‘In January alone, pension deficits on such schemes rose by £100billion to an alltime record of £370 billion. This level of liability is bad for companies and one way to reduce it is to get members to take a transfer value and move their money elsewhere.’
People transferring out of a defined benefit pension scheme will only be allowed to do so if they receive advice. But Moss says this advice will not be rigorous enough.
‘It will simply focus on whether the transfer value is fair value,’ he says.
‘It is not designed to ensure a member understands all the risks of their actions before transferring.’
DON’T FORGET ANNUITIES
FOR many years, annuities have been the main way for people to turn lifetime savings into retirement income. But from the start of the new tax year, people will not be forced down the annuity route.
In most instances they will instead be able to draw down income from their pension as and when they want.
Yet annuities will still appeal to many people. Moss says governments in both Australia and the United States – after decades of
pension freedoms – are now looking at ways to encourage more retirees to buy guaranteed income products. Alan Steel, head of independent financial adviser Alan Steel Asset Management, based in Linlithgow, West Lothian, says: ‘What is key is that people who prefer a guaranteed income end up with an annuity fit for their circumstances.’ ALTHOUGH the Government has launched an information service (Pension Wise) for those looking to turn pension funds into cash or income, it will at best provide broad-brush guidance only.
Some even fear the service – delivered online, in person at 500 Citizens Advice offices and by phone via The Pensions Advisory Service – will struggle to cope with demand.
Moss says: ‘The lack of readiness of Government, the regulator and many pension providers is likely to result in a number of broken eggs in the next year.
‘This could result in many people’s retirement prospects being irreparably damaged.’
Steel says financial advice will benefit many. He says: ‘Since 1987, we’ve had 550 changes to pension laws. It’s a minefield out there so it will pay to use a pensions specialist who can explain all your options simply.’
Advice will not only be invaluable for those looking to retire. It will also prove crucial for those who decide to keep their pension funds invested throughout retirement, drawing down income when needed.