Do the new pension rules work?
Pension Flexibility has revolutionised retirement but not everyone has been able to access their savings due to high charges and restrictions from pension providers.
From April 2015, those aged over-55 have been offered access to their defined contribution (DC) pension, saving as cash lump sums or regular income, the choice is up to them.
There are two ways to access this money: flexi-access drawdown (FAD) and uncrystallised fund pension lump um (UFPLS). Both allow you to access your pension as you please but where they differ is in the way the money accessed is taxed.
Under FAD, the first 25% of money you take is tax-free, meaning a person with pension savings of £100,000 would pay no tax on the first £25,000 they take out and the rest would be taxed as income.
However, under UFPLS, the first 25% of every chunk of money is tax-free and the rest is taxed at your marginal rate of income tax. This means that a person with a £100,000 pension pot taking £20,000 out would not pay tax on the first £5,000 but would pay income tax – if any is due – on the remaining £15,000.
If you want to access your pension money, you will have to make a decision about which route to take. Your pension scheme won’t just hand over the cash. Pension schemes are not even obliged to offer drawdown, meaning some retirees will be forced to transfer out of an old pension scheme and into a new one – at their own expense.
Michelle Cracknell, chief executive of The Pensions Advisory Service that runs the government’s Pension Wise guidance service, says there is a misunderstanding among many people that their pension scheme will just hand over their savings.
“The journey people have to go through is often in three stages,” she says. “You exit the old contract, and in the middle you may get advice... and the third stage is buying a new contract.”
A total of 204,581 people accessed their pensions in the first three months of pension freedom but there is no exact figure on how many were prevented from getting their hands on their cash. However, complaints data from the Financial Conduct Authority (FCA) indicates there is a large number of people unhappy with how pension freedom rules have, or haven’t, been implemented.
Complaints relating to ‘decumulation, life and pensions’ totalled 73,055 in the first half of this year, up 19.7% on the second half of 2014.
Of these complaints, 1,341 were about income drawdown. Although this is a relatively small figure, it has jumped by 88% from 714 in the previous six months.
Jamie Jenkins, head of pensions strategy at Standard Life, says it is unclear to retirees that providers do not have to offer drawdown options on their pension schemes. “One of the key points of the government legislation [around pension freedom] is that they recognise not every provider or scheme would offer [drawdown], so there is the right for people to transfer [out of the existing pension and into a new one] – they are not stuck with a provider and that is the important part,” he says.
When purchasing a drawdown product, price is obviously at the forefront of retirees’ minds as they want to lose as little of their pension to fees as possible.
Watch out for fees
Lots of companies are making noises about low-cost drawdown products but individuals should be aware there are myriad fees to contend with, including set-up charges, fees to alter payment dates, charges for one-off payments, and administration costs (and that’s before you factor in the cost of your investments (which have separate annual management charges), plus possibly fees for advice.
Moneywise reader Paul Relf questioned why he cannot use his pension fund “like a bank account” and said one company had quoted him £180 for every withdrawal from a UFPLS.
In particular, Relf wanted to know why it costs so much for withdrawals when drawdown providers have to do little but provide access to the savings. He pointed out that drawdown no longer requires providers to calculate ‘GAD rates’ – these ‘Government Actuary’s Department’ rates used to set the amount of income that can be taken from a ‘capped drawdown’ policy, when this type of drawdown no longer exists.
“If there are excessive charges and it is hard to withdraw UFPLS, then it seems to me to undermine the pension fund reforms and the aim of the chancellor that you can use your pension fund like a bank account,” said Relf.
Jenkins says “the point about GAD rates is a good one” and that providers “no longer have to look at GAD rates which is a removal of cost”, except for existing capped drawdown policyholders.
“This is a great example of where the old world of drawdown and the new world of drawdown differs dramatically,” he added.
Jenkins expects to see costs reduced over the longer term as “charges have only been going one way for the last decade and rightly so”.
Malcolm McLean, pension consultant at Barnett Waddingham, says the £180 fee Relf was quoted for a withdrawal was “over the top” and he “sincerely hopes” that isn’t an average figure for drawdown withdrawals.
McLean says there were concerns about drawdown costs and a cap on the costs has been called for, most notably by consumer campaign group Which?. “It’s a question people ask all the time: what are we paying for and what will I get back in retirement,” he said. “There is a concern about drawdown charges and how they vary and the FCA is looking at this to see if we need greater control now.
“Drawdown is unchanged from what it was except you do not have to get involved in GAD limits, but that was always a one-off initially. That was also done by the independent financial adviser who set up [the drawdown contract] and not the provider themselves.”
Providers under fire
He believes that some providers are struggling to deal with the new freedoms and high charges are used to actively discourage people from accessing their cash.
“The charges are to put people off going down this route,” he says. “Some of [the providers] recognise that their admin systems are creaking under the strain and they are imposing charges to make sure not too many of [these policies] are in operation.”
However, McLean adds that individuals should not be fooled into thinking that pensions can be used in the same way as bank accounts, despite being told they could.
“A pension fund is different to a bank account,” he says. “There is an analogy to bank accounts in drawing money out but the different is you have a tax charge to consider [with pensions] and the provider is not geared up to let pension funds operate like bank accounts.”
One of the problems for consumers wanting to go into drawdown is the inability to compare charges, with even the experts finding it difficult.
Holly Mackay, head of financial website Boring Money, has been comparing products her entire career but when it came to drawdown comparison, she says: “I can’t actually do it”.
She says it was “impossible” to price a certain scenario for a pension fund of a certain size, managed in a certain way with specific investments, and then compare the charges from different drawdown providers. Mackay expects the regulator to have to step in to make it easier to compare costs.
The lack of a simple ‘vanilla’ drawdown products is behind the costing issue, believes Cracknell. “The problem is nothing in the market is a vanilla drawdown contract,” she said. “[The ones available] offer lots of options, which are factored into the price.”
Forced to take advice
Cracknell says costs are a huge concern for people who contact Pension Wise and that concern is linked to accessibility. She gave the example of one retiree who phoned Pension Wise about a £500 charge for withdrawing his money. However, the provider actually required the retiree to take advice from either an IFA or its own in-house team, if they wanted to cash in their pension and the cost for the in-house advice was £500.
“They said they were charged £500 to take their money out but they had concertinaed the whole process,” she said. “People think they will just be able to get their money. We hear inaccessibility problems most often and then that also means people are aware of incurring charges.”
Part of the inaccessibility issue is that the regulator requires anyone in a DC scheme who has a guaranteed benefit – such as a guaranteed annuity rate – worth over £30,000 to take advice before they can cash in their pension. However, on top of this, some providers are gold-plating the rules and requiring all retirees cashing in to take advice, regardless of the size of the pot.
“So me providers say you have to go down the advice route,” says Cracknell. “A number of providers put that requirement in so they can say all their drawdown business is intermediated. It may be written into their terms of business that everyone going in to drawdown has to get advice.”
If you are unhappy with the terms offered by your pension provider or the amount they charge for accessing your cash, then the only option is to transfer out. However, you should be prepared to pay for moving your money.
Out of the 200,000 people who accessed their money in the first three months of pension freedom, 16% – or 32,000 people – were hit by an exit charge for moving their money into drawdown. Exit fees can be up to 5% of the pension pot.
Alternatively, you could wait for drawdown products to come on the market that are simpler and therefore cheaper.
Jenkins expects simplified and lower cost products to hit the market and said providers were already working on new options for customers. Cracknell says that new products will come to market in time and people could wait for these developments to be offered.
Which drawdown product should you pick?
If you want to go into drawdown in the meantime, individuals should look carefully at what sort of drawdown product would suit them: FAD or UFPLS.
There is no general rule for which drawdown product is suitable and it will depend on your personal circumstances. For example, the subtle change in taxation makes a big difference if you want to continue saving into a pension. If you use UFPLS, then your annual allowance – the amount you can save each year into a pension and receive tax relief on – falls from £40,000 to £10,000.
Cracknell says retirees should also take into account their own personal income tax situation.
“The first thing to consider is your tax position,” she says. “Higher-rate taxpayers will go for FAD if they just need a lump of money because they can take the 25% tax- free lump sum and leave the rest untouched.”
Your circumstances will also determine which charging structures would be cheaper for you; providers will charge either a set fee for things like withdrawals or a percentage of the fund each year.
“It depends if you only want access to the money for high days and holidays but you won’t then access it for another six years but if you want to access it every year then you will have to work out which charging structure will be best,” says Cracknell, adding that those who need infrequent access may want to consider one-off charges rather than paying a percentage annually for services they are not using.
“Also look at whether they are charging a percentage or pound fee [in relation to] the size of the fund as a large fund may find a percentage fee too much,” she adds.
If in doubt, retirees should get independent advice on which drawdown product is best for them.
“People need to take care that they are getting the right option for them and they need to get proper financial advice before they get involved in any new type of scheme,” says McLean.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
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.
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.