Pension Clinic: overall, the pension freedoms have been a success, but various obstacles need to be navigated to stop people making poor choices. The former pensions minister discusses areas of concern.
The pension freedoms implemented in April 2015 have been one of the most popular changes to pensions in recent years. Until the changes, most people had little choice but to turn their pension pot into an income for life by purchasing an annuity. But with interest rates at historically low levels and a poorly functioning annuity market, many were getting disappointing value for money.
Pension freedoms changed all of that, widening the net so that all savers have access to options previously open only to the relatively wealthy. Rather than buy an annuity, individuals can today take all of their pension pot out in one go, choose to take their tax-free cash and leave the rest invested in a drawdown account, or alternatively take chunks with a mix of taxable and tax-free cash. Moreover, growing numbers of people have even opted to transfer from the (relative) security of a defined benefit or final salary pension scheme into a defined contribution pension in order to access the new flexibilities.
However, a recent report by Age UK concludes that the pension freedoms may not be good news for all. Instead, the charity believes that some people may make poor choices and end up running short of money in retirement. So, what is Age UK concerned about and how justified are its concerns?
Not taking advice?
First, Age UK is concerned that too few people are taking advice or guidance. The government did set up a free and impartial Pension Wise service to talk people through their options around the pension freedoms. But Age UK says that too few people are getting guidance from Pension Wise and may make poorly informed choices as a result.
Those who have used the Pension Wise service, whether online, on the telephone or via a face-to-face meeting, generally rate it very highly. But, the trouble is, by the time someone contacts their pension provider to access their money, they have often already decided what they want to do. The antidote is to get people to engage much sooner.
Pension providers should contact people at least five years before pension age and this should be a prompt to have a conversation with Pension Wise. There is also talk of “mid-life MOTs” where people can review their finances and their career, and this would be another chance to nudge people towards talking to Pension Wise.
A second risk is that too many people move their money out of their pension pot and into a low-return savings account such as a cash Isa. A lot of people are very focused on accessing their tax-free cash and don’t really know what to do with the rest of their pension fund until they need it.
It is vitally important that people are not “recklessly cautious” and are encouraged to take an appropriate level of risk. Given that someone accessing tax-free cash at 55 probably needs the rest of their pension to support them for another 30 years, investing too cautiously too soon is likely to produce poor outcomes.
Age UK also made the point that most people do not understand the tax and benefit implications of accessing their pension pot.
On the tax front, it is important to be aware that when the first taxable withdrawal is made from a pension pot, HMRC often levies tax at an “emergency” rate. Any excess tax can generally be claimed back, but some people may be shocked that the amount that reaches their bank account in the first instance is much lower than they expected.
Regarding benefits, money in a pension fund that can be accessed may be considered by the benefits authorities when assessing your entitlement to means-tested benefits. Although they cannot force you to take money out of your pension they can, for example, “deem” you to have an income based on the amount in the pot. This may reduce the amount of benefit you can claim.
Running down the pot
Similarly, someone thought to have run down their pot unusually quickly, perhaps with a view to becoming entitled to benefit, can also find that they are “deemed” to have more money in their pension pot than is actually the case. These issues may be especially important for those on modest incomes who are on the cusp of the benefit system.
Pension freedoms remain a good thing in my view, and have been positive for large numbers of people. But Age UK is right to highlight the fact that people can get things wrong if left to their own devices, and that more people taking up advice and guidance would help them to make the best of these freedoms.
Steve Webb is director of policy at Royal London.