Most over-55s are behaving 'rationally' with their pension savings - are you?
Investors have withdrawn £2.5 billion in cash lump sums from their pension pots in the past six months since the new freedoms came into effect.
According to new figures from the Association of British Insurers (ABI), investors have mostly cashed in smaller pension pots - with 166,700 payments being made, averaging just under £15,000. In terms of drawdown, the ABI claims providers have made 606,000 income drawdown payments with an average of £3,600 - a total of £2.2 billion.
Generally speaking, people have used their smaller pots for lump-sum payments and relied on their larger pots for retirement income.
'As expected, customers are taking smaller pots as cash and using larger pots to secure an income - about 40 per cent with an annuity and 60 per cent with a flexible income drawdown product,' says ABI chairman Paul Evans. 'Around half are now switching away from the company they saved with to secure the best deal for their retirement income. Overall, customers appear to be behaving rationally.'
A report from Which? found that drawdown customers with a pot of £250,000 could face a difference of up to £10,000 in charges, depending on which provider they used, while last year the Financial Conduct Authority (FCA) found that four-fifths of people who purchased an annuity from their existing provider could have got a better rate elsewhere.
Annuity sales have also made a surprise comeback, recording their first quarter-on-quarter increase for the last three years with 22,380 sold worth £1.17 billion. This represents a 23 per cent rise in sales volume and an 18 per cent rise in terms of amount spent.
Will annuities get a second life?
They still have a great deal of ground to make up before reaching anywhere near their sales figures from last year, however. Last month the ABI revealed that annuity sales had fallen by 80 per cent in the second quarter of the year.
Dr Yvonne Braun, director for long-term savings policy at the ABI, says: 'Despite some ringing the death knell for annuities, this seems to have been premature. An increasing number of people are recognising the value of a guaranteed income, with annuity sales rising this quarter.
'There are also initial signs that the number of people accessing their pension pot as cash is beginning to settle down, with larger pots continuing to be used to buy retirement income products.
'However, the figures also show that ensuring people save enough for retirement remains our key challenge. With life expectancy increasing and final salary pension provision declining, we must now turn our attention to helping customers grow bigger pots.'
Pinch of salt
However, Hargreaves Lansdown's head of pension research Tom McPhail says one should take the ABI's figures with a pinch of salt.
First of all, the data lumps together income drawdown withdrawals from arrangements made before the freedoms came into effect with those taken from plans actually established under the new freedoms - meaning the numbers are not strictly comparable with previous years as an indicator of how people are taking advantage of the new pension rules.
Also, the ABI's figures are not representative of the entire market - leaving out data from Hargreaves Lansdown and other large drawdown providers.
'We have seen a series of reports on how the pension freedoms are working, with the ABI, HMRC and [FCA] all publishing data, and not all of it has been consistent. We think the FCA's probably looks the most relevant and reliable but we shouldn't be having to guess at this stuff,' says McPhail.
In September, the FCA reported that 71,455 people had accessed some form of drawdown option in the first three months after the freedoms came into effect, while 120,688 people accessed some form of cash withdrawal. The watchdog also said annuity sales for the period stood at 12,418 - compared to almost 90,000 during the same period the previous year.
Pensions consultancy Hymans Robertson estimates people will take a combined £6 billion from their pensions this year - meaning that the government will enjoy a tax take almost four times its original estimates.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.
Association of British Insurers
Established in 1985, the ABI is the trade body for UK insurance companies. It has more than 400 member companies that provide around 90% of domestic insurance services sold in the UK. The ABI speaks out on issues of common interest and acts as an advocate for high standards of customer service in the insurance industry. The ABI is funded by the subscriptions of member companies.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.