What are the 'pension pioneers' doing with their savings?
There is no ‘normal’ way to approach retirement planning, since April’s pension reforms.
Just one in five retirees have been buying an annuity – the traditional route , with the rest taking cash or drawing funds directly. Many are afraid to make any decisions at all.
The report from the Pensions and Lifetime Savings Association aims to identify what 55-70 years olds have been doing in the wake of April’s pension reforms.
It focussed on the 2.8 million people within this age range with at least one defined contribution pension that was not yet in payment and found three clear groups:
14% were ‘Actioners’ who accessed their pensions for the first time
63% were ‘Investigators’ who were actively considering their options
23% were ‘Inactive’ – often because they were still working or did not currently need to access their pension.
Joanne Segars, chief executive, Pensions and Lifetime Savings Association says: “The message that comes through loud and clear from our research is that there’s no more normal when it comes to deciding what to do with savings at retirement.
“Pensions freedoms have destroyed the traditional norms, leaving a blank canvas for millions of people. This first cohort of savers are effectively pension pioneers – working out how to make the right decision with their savings but at the same time naturally fearful of making a poor decision in unchartered territory.”
Of those that had accessed their cash 37% had simply taken their tax-free cash, 27% went into income drawdown, 20% bought an annuity and14% made a cash withdrawal (with or without tax-free cash). Just 1% used a combination of cash, annuity and drawdown.
Get the low down on your options with our guide to retirement income.
More than half (57%) spent some money and saved some, 19% saved or invested it all, 18% spent it all and 6% donated the money.
A third of the spenders paid for home improvements with their money, 18% made a one-off purchase, 14% paid off a loan or credit card, 12% paid off their mortgage and 3% gave it to family.
However, the PLSA reported that ‘Actioners’ are a ‘distinct and affluent’ group. They have above average pension wealth and experience of managing investments. It concluded that the retirees that follow this first wave may not necessarily behave in the same way.
Nathan Long, head of corporate pension research at Hargreaves Lansdown says: “The research shows those quickest out of the blocks with the new pension freedoms were more financially savvy than those who will access their pension in the next few years. This supports the finding that the next wave of retirees will be more inclined to buy annuities than those who were first to test drive the new pension freedoms, who have favoured remaining invested through retirement.”
Despite the claims that this group was financially savvy he expressed concerns about what savers were doing with their money.
“An awful lot of money seems to have been taken out of pensions to be held as cash. For many people, the combination of tax on pension withdrawals and low interest rates on cash mean their money may be better left in their pension until needed,” he says.
Read Moneywise’s guide to how to live in retirement.
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.
Defined contribution pension
Often referred to as a “money purchase” scheme, although offered by employers (who may pay a contribution) these pensions are more likely to be free-standing schemes that a person contributes to regardless of where they are employed. Here, the level of benefit is solely dependent on the accumulated value of the contributions and their performance as investments. Therefore, the scheme member is shouldering the risk of their pension, as the scheme will only pay a pension based on the contributions and investment performance. The final pension (minus an optional 25% that can be taken as tax-free cash) is then commonly used to purchase an annuity that would provide an income for life.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
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.