Beware the dangers of pension freedom
Few areas of personal finance have undergone such dramatic change in recent years as our pensions.
Indeed, the rule changes have been so rapid and so often that it is now nigh impossible to understand what we can – and can’t – do with our pensions.
Persistent government meddling has resulted in the near death of the defined benefit (otherwise known as final salary) pension scheme in the private sector (they still thrive in the public sector, which may irk some taxpayers) although given what Sir Philip Green has allowed to happen to the BHS pension fund, some would say we are best rid of such arrangements. The BHS scheme has a deficit of £571 million, which means there is little prospect of members being paid the pensions they were promised.
The near termination of defined benefit schemes has resulted in the pensions scene now being dominated by defined contribution plans – where we, as savers, take all the risks. With every fall in the stock market, our hearts – and retirement funds – sink.There’s little we can do about it, other than pray or use our pensions to save into cash, a strategy adopted by Paul Lewis of BBC Radio 4’s Money Box fame.
On the positive, the introduction of auto-enrolment has nudged more than six million employees into taking out a pension – although the amounts being saved are hardly earth shattering (in most instances, no more than 2% of earnings), advice it’s a step forward rather than backwards.
Yet of all the pension changes in recent years, the most dramatic one has been the right for people to access their pension. This new pension freedom regime, introduced in April last year, has transformed the pensions landscape, giving millions of people greater control over how they use their long-term savings to fund their retirement.
I have been a fan of the pension freedoms from day one. Some 15 months on, I see no reason to change my opinion, yet this new pensions world is not without its problems.
First, fraud remains a real problem as criminals seek to exploit the new freedom regime to rob us of our pension pots by bombarding us with texts or cold-calling us. It’s an issue that the regulators and the Department for Work and Pensions need to tackle. These criminals should be pursued until the ends of the earth, put out of business and locked up.
Second, there is a chronic lack of affordable advice available to those embarking upon the pension freedom journey. Guidance, yes, but not professional financial advice as given by a qualified financial planner.
The result is that many people are not doing enough to ensure their retirement funds are built to last. In some instances, they are falling victim of ‘pound cost ravaging’ – drawing an income from their pension at the same time as the underlying investments are falling in value.
This double hit can have a devastating impact on their pension fund’s ability further down the line to maintain income payments. Since pension freedom came in, the FTSE100 Index has fallen by more than 13% (to 17 June 2016), reducing the value of most pensions in draw down (where an income is being taken).
There are various tactics that can be employed to mitigate this pound cost ravaging risk – taking less income from your pension, using alternative investments, such as Isas, to provide an initial income in retirement, and ensuring your pension is invested in a diverse range of assets. This can mean considering assets that you might have thought were passé – with profits, for example, a type of fund offered by some insurance companies.
They’re a form of managed investment that seeks to smooth out the ups and downs of the investment markets.
Also consider structured investments that, in some instances, pay positive returns even when markets have fallen. Some structured investments offer you a lump sum at maturity depending on the performance of the stock market index or other measure.
Others let you take a regular income and whether or not you get back your original investment in full depends on how the stock market index or other measure has performed.
If you have are about to embark upon your right to pension freedom, please proceed carefully. And at the very least, think about getting some quality financial advice. It might well save you from financial Armageddon.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.