The biggest pension freedom mistake to avoid
Two years after the pension freedoms began, 41 per cent of retirees who took out a cash lump sum from their pension pot, decided to stash this money away in a current account, according to research by Fidelity.
Previous research found that on the whole as much as a third of retirees take out cash from their pensions to pay off existing debts.
Fidelity’s research sampled a relatively small sample of 504 people who had accessed their pension since April 2015. It found that the’ Class of 2015’ had used their cash lump sum for everything from paying off debt to financing holidays. But the most popular choice was putting it into a current account which ignores rising inflation and risks eroding people’s pension earnings.
Further, this choice doesn’t tally with retirees’ concerns as nearly three quarters of those who had accessed cash and gone into drawdown (73 per cent) said that low interest rates were their biggest worry for their pension monies.
Even market leading accounts only offer a maximum of £122.25 in interest payments for just £2,500 in the first year, according to Fidelity. Therefore the biggest risk is not taking any risk and losing out as UK inflation continues its march upwards.
Maike Currie, investment director at Fidelity Personal Investing, points out that rising inflation and low interest rates are a toxic combination for retirees. Beyond the rise of day-to-day living costs like food and fuel, inflation also wreaks havoc with their pension savings. It erodes the spending power of future interest payments and chips away at their capital.
She says: ‘It’s concerning that retirees worry about low interest rates but then still choose to leave their hard-earned pension savings languishing in cash. Most soon-to-be retirees look forward to their 25 per cent tax-free cash lump sum with anticipation and excitement, and should enjoy this pension sweetener as they see fit, however, leaving it dwindling in a cash account could leave them short changed in the future.
Considering that a healthy 55-year old could expect to live for another 30 or 40 years, most retirees can afford to give their tax-free cash sum room to grow by investing rather than seeking shelter in cash, notes Currie.
It may also be prudent to maintain the same level of risk that was in place prior to retirement. Rebecca Taylor, a certified financial planner and managing director at Aurea Financial Planning, has previously made the point that as retirement portfolios are there for the long haul, the investments chosen need to cater for the fact that people are living longer.
Currie adds: ‘Our calculations show if you had invested £15,000 into the FTSE All Share index five years ago, you would now be left with £23,288. If, however, you had invested £15,000 into the average UK savings account over the same period, you would be left with a paltry £15,122. That’s a difference of over £8,166.’
Other research supports this point. Schroders found that a saver who had put £1,000 into a cash Isa when they were launched in 1999 would now have £1,204. If the same £1,000 had been put into a stocks and shares Isa and invested in the UK stock market it would be worth £1,663, or 38 per cent more.
The stock market beat cash by 38 per cent even though the launch of Isa coincided with the dotcom boom, which has followed by bust soon after. The 18-year span for the data also included the financial crisis of 2008 and 2009, one of the worst market crashes in history.
Despite the historic strong performance of shares, HMRC data shows that the popularity of cash Isas dwarf that for stocks and shares Isas. The difference has also steadily increased since the global recession in 2008.
In 2015/16, savers subscribed to 12.5m Isa accounts. Eighty per cent of these were cash Isas and only 20 per cent were stocks and shares Isas, the lowest proportion since 2007/08.
But those who are overly cautious are likely to lose out in a low interest, inflationary environment. Therefore putting cash into current account may be the biggest pension freedom mistake to avoid.