Pension Freedoms was a big change in legislation. It now means that anyone age 55 or over has significantly more flexibility in how they draw income from pensions. Coming into effect in April 2015, it was a revolution in retirement planning.
Around the third anniversary of Pension Freedoms my network, Beaufort Financial conducted research to better understand consumer awareness among over 50s. The findings were concerning;
- Many were in the dark about Pension Freedoms and what it entailed. Our YouGov poll of more than 2,000 people showed around 40% were completely unaware of Pension Freedoms.
- A gender gap was also identified; over 50% of women were unaware of the rule changes compared to 30% of men.
- The likelihood of people seeking financial advice was also slim; for those not yet in retirement just 12% said they were more likely to seek advice if it meant they could retire earlier. Particularly surprising, as we regularly help people retire early and move on to the next phase of life as soon as possible.
A lack of awareness and seemingly nonchalant attitude towards advice is a real worry. However, identifying an issue is only half of the challenge. Here is our solution; 15 things you need to know about Pension Freedoms and your retirement.
1. You’re not obliged to buy an Annuity
Long gone are the days of having to purchase an Annuity. Pension Freedoms mean you have flexibility to use your pension fund as you see fit from the age of 55. There are now far more options to consider; an Annuity still one of them, if you find solace in a guaranteed income.
2. You control your income
Pension Freedoms removes the cap on the amount you can take from your pension. You can mould withdrawals, either as lump sums or regular income, to suit your needs from age 55. Only withdrawing what you need will minimise any income tax you will pay.
3. You could retire earlier
The ability to draw flexible income from age 55 means you may be able to retire sooner, only making
withdrawals when you need them. You may want to make larger withdrawals until state pension kicks in, then reduce your income to increase the longevity of your pension fund.
4. Continued growth
Whilst taking flexible income your pension fund can remain invested. Potential investment returns would therefore also increase your pension’s longevity
5. Withdrawing everything
We waited until number five, but this is the big one; from age 55 you can withdraw your whole pension, in one go. 25% of it tax-free (like the old rules), the remaining 75% will be added to your income in that year and taxed appropriately.
In 2014 the former Pensions Minister famously said pension funds can “be used to buy Lamborghinis”. People have typically been more sensible, but the decision is yours to make!
Many people have taken up the option, especially with smaller pensions, but you need to ensure it doesn’t cause long-term harm to your future financial security.
6. Tax-free cash flexibility
Before Pension Freedoms people typically took their 25% tax-free cash as a lump sum and purchased an annuity with their remaining fund. The formal name for tax-free cash is a ‘Pension Commencement Lump Sum’, which is a bit misleading as it doesn’t have to be a lump sum and it doesn’t have to be taken when you commence drawing income.
You have the flexibility to take tax-free cash when you want; it can be taken as regular income, in chunks, or in its entirety whenever you see fit. This flexibility can help reduce income tax, keeping more money in your pocket.
7. What if you’ve already bought an annuity?
The Government previously proposed the ability to transfer out of an Annuity for a lump sum, but it never came to fruition. If you bought an Annuity that’s it, unless, in the rare circumstance it is worth less than £10,000, you may be able to transfer it as a lump sum at the provider’s discretion.
8. Defined Benefit schemes can be transferred
Defined Benefit (also known as Final Salary) pensions were traditionally favoured by employees thanks to the guaranteed lifetime income they offered. Since the introduction of Pension Freedoms there has been a significant rise in the number of people transferring out of Defined Benefit pensions to take advantage of increased flexibility. In fact, between 1st April 2017 and 31st March 2018 at least 72,700 transfers were made from Defined Benefit schemes, totalling around £14.3 billion.
Transferring your Defined Benefit pension is a big decision; those who do will give up a guaranteed income and can never change their mind. Making the wrong decision could be ultimately costly, but large transfer values may be tempting. As ever, it’s best you seek advice if you have a Defined Benefit pension.
9. Better death benefits
Pension Freedoms brought some big changes to the way death benefits are paid and taxed. Broadly speaking, if you die your pension can either be paid to the beneficiary as a cash sum or kept within a pension environment. By doing the latter, the recipient would benefit from flexible withdrawals and other Pension Freedoms benefits, but also the ability to tax efficiently pass wealth down to other generations.
Tax liability depends on the age when you die; under 75 and the funds are inherited tax-free. After 75 years of age, any death benefits taken will be liable for income tax.
10. Reduce Inheritance Tax
Increased flexibility may encourage you to save more in pensions, safe in the knowledge it’s accessible. Pensions are not typically liable to Inheritance Tax when you die, so additional pension saving would reduce any potential Inheritance Tax liability.
11. It can run out…
It’s a concern that the new-found flexibility and no income cap may be going to some people’s head, and they are withdrawing too much. HMRC data does show that 1.8 million people have withdrawn more than £17.4 billion from their pensions. In fact, during the first three months of 2018, 222,000 people withdrew a total of £1.7 billion!
Further research from AJ Bell shows that 41% of people are withdrawing more than 10% of their pension a year. These people run a very real risk of running out of income after just eight years, even allowing for an optimistic investment return.
Considering pension longevity, there are three points;
- Your life expectancy: Nearly 80% of people over the age of 50 significantly underestimate their lifespan, putting them at an increased risk of an income shortfall.
- Unplanned costs: As an aging population we are living longer, less healthy lives. Care costs are significant and will make a big dent in your pension when it’s value is potentially at its lowest.
- Purchasing power: Over time inflation makes a big difference to the value of cash. The FCA recently published a report showing that 33% of non-advised people taking pension income are wholly holding cash, with no investment element at all. In real terms, that will have a detrimental effect on their pension longevity.
12. You can top it back up, to an extent
If you haven’t started making withdrawals you can pay up to a maximum £40,000 a year tax-free in to your pension. However, if you’ve started making withdrawals, as of 2017, the limit is dramatically
reduced to £4,000 a year. Anything above this figure will be taxed.
Still, if your pension fund is dwindling in retirement and you have other income streams, such as
continued employment, you do have the opportunity to make additional, albeit limited, contributions.
13. Beware of fraudsters
The level of publicity around Defined Benefit transfers, no ban on cold calling and historically low interest rates, has been a perfect storm for fraudsters to take advantage of. A recent survey found that since Pension Freedoms almost one in ten over-55s said they have been approached about their pension by people they believe to be a fraudster.
Tactics usually focus around unlocking benefits early or offering alternative investments. The adage still rings true; if it sounds too good to be true…
14. You shouldn’t ignore it
A missed opportunity may be as damaging to your pension planning as a poor decision! The best way to minimise either risk is to seek professional advice.
15. Advice is as important as ever
Pension Freedoms offer you so much more choice, financial advice and planning is more relevant than ever. There are, of course, great opportunities to take advantage of. On the other hand, the biggest threat is arguably running out of income.
Understanding how to best manage your retirement is where we come in; at Beaufort Financial, our service combines the ‘art’ of knowing and understanding your life goals, with the ‘science’ of identifying the best financial solutions to help you to achieve them.
If you would like to discuss your retirement options, please get in touch.