In a matter of weeks, it’s out with the old and in with the new for pensions. Nearly every aspect of retirement saving has been revolutionised over the past year. The most important reform of all is that from April 2015 you can take as much cash as you like from a ‘defined contribution’ pension, with no obligation to buy an annuity.
New pensions freedom: save, spend or invest
The unprecedented pension freedoms give over-55s the power to spend, save or invest their money as they see fit:
- You could can treat your pension as a bank account, dipping in and out as often as you like and taking a quarter of it tax-free (with the rest taxed as income).
- Alternatively, you can keep the money invested and draw an income from it as you need (a process called drawdown).
- You may prefer to go down the annuity route and convert some or all of your money into a guaranteed income for life.
- Or maybe you want to cash in the whole lot and invest it somewhere else? The choice is yours.
“Pensions have finally caught up with real life. Now people in the UK can save for retirement in the knowledge that their pension savings can be used flexibly,” says Alan Higham, retirement director at Fidelity.
“The system we had was broken and loaded against the consumer. People were funnelled into buying an annuity, which was good in providing a secure income for life; but not much else.”
Why pensions change is needed
These reforms come off the back of stark warnings that almost 12 million people aren’t saving enough money for retirement. The government’s auto-enrolment programme, whereby employees automatically join their workplace pension unless they actively opt out, is a major step forward in encouraging a culture of long-term saving.
The new freedoms go one step further and, with the restrictions swept away, pensions are starting to look like a no-brainer for retirement savings.
You still get tax relief from the government on the money you pay in – boosting a £60 monthly contribution to £100 if you’re a higher rate taxpayer – not to mention employer-matched contributions if it’s a workplace pension.
The big difference is that under the new pensions system you get that money back under much more relaxed and tax-efficient terms from retirement age.
So, if you’re still working, you will be free to draw small chunks over time, which could reduce your tax liability entirely. Or you can take the cash and put it into alternative investments such as property, the stock market, cash savings, or anything else that takes your fancy.
Equally, many people will prefer to combine several solutions, perhaps blending an insurance-style product with a drawdown product.
The risks of greater pensions choice
The downside of greater choice and control over your financial future is greater responsibility.
The new system has risks, namely that people may make poor decisions with their new freedoms. This could result in some of us paying more tax than we need to, or ultimately running out of money altogether.
The government has committed to giving half an hour of free guidance through its Pensions Wise service (online, over the phone, or face-to-face), which is designed to help people navigate the new system. But this will only provide broad guidance, not specific advice. So it’s important for you to increase your own financial awareness.
The challenges of the pension reforms
Pension schemes won’t be ready One major stumbling block is whether employers will actually be ready to deliver the level of flexibility being offered under the new regime. There is still a question mark as to whether pension schemes will have the time or administration in place to offer bank account-style services by April.
If they aren’t, the only option may be for members to sit tight and wait, or transfer their pensions to a third party which could incur hefty charges.
You underestimate your life expectancy Even if this is plain sailing, there is a danger that people who are retiring will continue making the same mistakes. For starters, more than eight in ten of us underestimate our life expectancy. The truth is that we are all living much longer and feasibly some of us will be looking at 30 years in retirement, so careful planning is crucial.
Not maximising your income Hundreds of thousands of people also miss out on extra cash every year simply because they don’t look for the best possible income. If new retirement products come to market it’s important that you shop around and compare charges, in order to get the most out of your retirement savings.
Your investments can go down as well as up Investment risks and tax consequences cannot be ignored either. While money in low-risk assets such as cash may not maintain spending power, money that remains invested is vulnerable to the ups and downs of markets.
Withdrawing your cash too quickly When the time comes to start drawing benefits, if you withdraw cash too quickly you could be pushed into a higher tax bracket, which could be easily avoided with even the most basic tax planning.
A chance for investment scams
With around 300,000 people a year able to access their pensions on demand post-April, experts have warned that it could be open season for con artists. Dodgy firms promising stellar returns will have the perfect opportunity to persuade unsuspecting savers to invest their entire pension in illiquid, risky or fake investments.
Morten Nilsson of NOW: Pensions says: “The new pension freedoms give shady operators a golden opportunity to target vulnerable yet potentially cash-rich retirees with illegal, expensive or highly speculative investment propositions.
“In the worst case scenario, victims of these scams can lose some or even all of their retirement savings, leaving them having to live off a state pension and benefits for the rest of their days.”
Get regulated financial advice
With so many potential problem areas, professional help is a sensible route. If you’re only going to pay for regulated advice once in your life, retirement is the time to do it and an independent financial adviser (IFA) should be able to tailor a plan to your personal circumstances and tax position.
More importantly, there is redress through the Financial Services Compensation Scheme (FSCS) if they go bust or give you negligent advice.