Politicians, consumer groups and the investment industry, in general, welcomed the pension freedoms introduced by the government in April 2015. The changes gave people more choice and flexibility in how they funded their retirements.
However, the sweeping nature of the reforms has caused one or two problems. Earlier this summer, the Financial Conduct Authority (FCA) published its initial study of the new system, alerting savers to potential risks.
While the watchdog sees no reason for urgent intervention, it does believe there are some areas of concern – in particular for savers who make important financial decisions without first obtaining independent, expert advice.
What are the pension freedoms?
Before 2015, most people who reached retirement had little choice but to buy an annuity with their pension fund. An annuity is a financial product that converts a lump sum into a regular, guaranteed income for life.
Under the post-April 2015 system, there are a number of alternatives to annuities. The main one is ‘drawdown’. Your pension pot can remain invested, allowing pension savings to continue growing, and you can take money out in a way that suits you, rather than a set annual payout.
Why should the freedoms be welcomed?
The system has a number of benefits for both retirees and those looking to save into a pension.
Your money isn’t locked up. Previously, many people were put off saving into a pension because their money would be tied up – and even at retirement, it could only be used for an annuity.
Under the new system, you can access your money from the age of 55, and there’s more choice about how it can be used when you reach retirement.
Your pension pot can continue to grow. By keeping a pension fund invested after retirement, it can benefit from future stock market growth. Most of us are living longer so it seems sensible to give your savings the opportunity to increase in value for as long as possible.
You are in control but seeking professional financial advice ensures you pick the option that’s right for you. You can still buy an annuity if you want the peace of mind that guaranteed income offers. But you can choose when to do so. And the longer you wait, the higher the rate – although that also means you’ll have less time to enjoy it. You can pass on wealth. Annuity payments stop when you die. (if you take a much lower rate, you can usually provide for a surviving spouse.) But any money left in your pension drawdown account can be passed on as a legacy, free of inheritance tax.
However, as the FCA report stresses, savers now have more responsibility for their finances in retirement, making it increasingly important to regularly seek expert advice both during your working career and in retirement. A bad decision could have serious consequences.
What are the areas of concern?
The big one is pensioners depleting their funds too quickly. The FCA report states that a lot of people are taking cash lump sums out of their pensions before the age of 65. It is now considering whether it needs new rules to protect savers who chose the drawdown route without first seeking expert guidance.
The FCA also recognises that more needs to be done to help individuals understand their pension options, as well as to improve trust levels in pensions in general.
As with any investment, there is an element of risk in a pension. And since drawdown schemes generally leave your money invested, you need to be sure taking that risk into retirement works for you.
While the FCA is right to draw attention to these potential pitfalls, two years on the overall message is positive. Savers have accessed more than £9.2 billion since the reforms.
A study from the International Longevity Centre showed pension savers who took professional advice are now an average of £40,000 better off. That’s a number that we at Pension Works can get behind.
Pension Works are on hand to help you understand your options and guide you down the path you choose to take. Get started with a Free Pension HealthCheck here.