Pension freedoms: what's happened since April?
On 6 April this year, the rules that dictated what we do with our hard-earned pensions were scrapped. Previously, you had to convert your pension into an income stream, which, for most of us, meant buying an annuity. Now every saver - not just the wealthy - can access more flexible income drawdown plans or simply take the cash.
It's this latter option that sent commentators into a headspin when the freedoms were first announced in last year's Budget. Then pensions minister Steve Webb said that over-55s were free to blow their pension on a Lamborghini should they so wish. Many in the industry expressed concerns that savers would fritter their savings away on cruises and home improvements, leaving them reliant on the state in their old age.
We're now a few months into the new regime and it appears the feared stampede for cash has failed to materialise. Paul Keeble, head of media relations at Retirement Advantage, says: "There was an initial flurry in those first weeks of April. Those people who might have been sitting on their hands during 2014 have taken cash but that has typically been from smaller pots." However, these levels quickly dropped. "We certainly aren't seeing people strip out larger funds," he added.
Murray Smith, a director at advisory firm Matioli Woods, has a similar view: "The basis that people would be taking money out to buy Maseratis and world cruises just isn't happening."
In many cases, notes Patrick Connolly, a financial planner at IFA Chase De Vere, those who are cashing in their funds are those who aren't reliant on the money. "People want to know what the changes are but they are not asking to take benefits. The exception is where we have clients with significant assets, who are cashing in smaller pensions because they do not need them to generate an income."
This anecdotal evidence is borne out by research from providers. Aegon, for example, says 11% of the people using its retirement planning tool are looking at lump sum withdrawals. Figures from Fidelity also show that only 6% want to take the cash, with small pots making up half of this figure.
While these figures certainly seem to suggest that Britain's savers have no intention of blowing their savings, they are keen to explore the new options open to them.
Fidelity says drawdown is the dominant theme - 61% of calls to its phone lines are from customers who want to go into income drawdown. Even so, a surprising number are in no hurry to start taking an income from it, with half of drawdown customers just taking their tax-free cash.
Previously, caps existed that limited the amount of income you could draw from an income drawdown plan (roughly the same as an equivalent annuity). Only those who could demonstrate alternative pension income worth £20,000 a year (lowered to £12,000 following the April 2014 Budget) could access the flexible drawdown that is now available to all.
As a result, it's not surprising that many people who took out capped drawdown plans under the old regime are now interested in converting to flexible plans which enable them to drawdown a higher level of income.
Steve Knight, chief operating officer at LV=, says: "Broadly speaking, conversations we have been having split into two camps: those already in drawdown who want to increase the amount of cash they can take and those who want more information about the reforms and their options."
However, while it might make sense to switch to a plan that does not restrict the level of income you take, it's not as straightforward as you would think.
Keeble explains: "It's a peculiarity of the regulations that when you move out of capped drawdown into flexible access your annual allowance is reduced from £40,000 a year to just £10,000." This could cause problems for people who are still working or who might be expecting a lump sum to top up their pension. "If you have a lump sum, such as an inheritance, £10,000 does seem quite limiting."
As such, LV= reports customers are not rushing to switch, with the majority remaining in capped plans.
It's no surprise that retirees aren't rushing to buy annuities. Until the pension freedoms were introduced, this was the default option for most people.
According to research by Hargreaves Lansdown, just 10% of investors were plumping for annuities in the first four weeks after the rules changed. Aegon reported 17% of users of its retirement planning tool explored taking out an annuity while only 3% of callers to Fidelity enquired about them.
Indeed, engagement with annuities all round appears to be low. Figures from Retirement Advantage show that less than 40% of people currently buying an annuity shop around for the best rate, compared to 50% this time last year. Keeble says: "The customer detriment is clear here - 7% of people who stay with their existing pension provider receive a better annuity rate because of a health or lifestyle condition. This compares to 60% who buy through an adviser."
Although annuity sales remain in the doldrums - as they have done since George Osborne's shock announcement in the 2014 Budget - the product has actually had something of a facelift as a result of the reforms. That is, you can now purchase guarantees that will ensure payments are made for as long as 30 years, irrespective of when you die.
This tackles one of the gripes retirees typically had about the product - that if you died before your savings had been fully spent, any remainder passed back to the insurer. "This pretty much ensures you get all your money back," explains Keeble.
Of course, guarantees come at a price – the longer you guarantee payments, the lower your income will be. Taking the example of a £50,000 pot, a healthy 65-year-old would get an annual income of £2,752. To guarantee income for 10 years, the policyholder would pay an insurance premium equivalent to £30 a year with annual income falling to £2,722. A 20-year guarantee would set them back £163 a year, meaning they'd get an income of £2,588, while the maximum guarantee of 30 years would cost £379 a year and provide £2,373 a year.
The inheritance tax equation
Following the changes, advisers are also talking to their clients about inheritance tax (IHT) planning. Under the new rules, money held in pensions falls outside your estate when you die, meaning it can be passed on to beneficiaries free of the dreaded IHT.
This means people may choose to keep funds tied up in pensions for as long as possible and spend other savings first. "We may see more people taking less out of their pensions now that it can cascade down through the generations," notes Smith.
This is currently a great boon for savers, with IHT liable at 40% on assets over £325,000. However, it may become less significant in the coming years as the Conservative party boasted it would increase the threshold to £1 million in its election manifesto.
Some observers have also noted that members of defined benefit (final salary) schemes have had their interest piqued – understandably so, given that freedoms are only open to members of defined contribution schemes and they might feel left out.
Fidelity says some 7% of callers are now interested into transferring their savings out of defined benefit and into defined contribution plans in order to access the new freedoms.
But in order to do this, the regulator demands that anyone with benefits in excess of £30,000 must seek the advice of an independent financial adviser (IFA) first – reflecting the benefits of a final salary scheme.
Martin Bamford, a chartered financial planner at Informed Choice, is one IFA who has had a number of enquiries from final salary scheme members wanting to cash in their plan. In many cases, he says, people don't understand the benefits of their existing policy.
"It's not always a bad idea but it means giving up valuable benefits such as inflation proofing and guaranteed income."
He adds that to cash in a plan, a saver would "need to have a definite need for the cash today, to have explored all the other options and demonstrate they won't fall on hard times later in life. So far, we haven't met anyone that this applies to".
It may not be the result of the pension reforms but another trend Fidelity is noting is a rise in the number of people who are being caught out by the reduction to the lifetime allowance, from £1.25 million to £1 million in 2016, which was announced by George Osborne in the March 2015 Budget.
Concern is split equally among those who are already over the allowance and those who are approaching it and want to know their options for protecting it. Government protection has historically been available for those whose funds have already exceeded this limit but it has yet to confirm details for those who will be caught out by this next reduction.
According to research from LV=, somebody with a pension worth just over £600,000 at the age of 40 could expect to reach the lifetime allowance by the age of 65 (assuming investment growth of 5%).
With the new regime still in its early days, further changes announced in the Budget and yet more expected in Osborne's post-election Budget on 8 July 2015, the pensions world has never been in such a state of flux.
As such, retirees are in no hurry to make big decisions. "People are just sitting there – we're calling it the 'pensions paralysis'," notes Keeble. And, where retirees are taking decisive action, they aren't doing anything they couldn't have done previously. "People are doing exactly the same as what they did last year. Cash aside, peoples choices are pretty much the same as they always have been," he adds.
This position could change in the near future – providers, for example, are beavering away at new products that should enable retirees to combine the guarantees of an annuity with the flexibility of drawdown but they aren't available yet and we don't know how well they'll work – or how much they'll cost.
On the plus side, Smith notes that as a result of the changes he's seeing younger clients get noticeably more engaged with their retirement saving. "There's now a new feeling of ownership with pensions," he says. "People can do what they want with their money including passing it down to future generations, and that's very attractive."
Your options in retirement
Take the cash: You can now take your entire pot as cash. However, only the first 25% is paid tax free, you need to pay tax on the remaining 75%. This money is taxed at your marginal rate (the highest rate of tax that you pay) and, depending on your income for that year, it may push you into a higher bracket.
Buy an annuity: In return for some (or all) of your pension savings, an annuity will pay you a guaranteed income for life. However, unless you purchase guarantees any funds that remain when you die will go back to the insurer. Any money paid out from guarantees or 'value protection' is taxed in the same way as income drawdown on death.
Go into income drawdown: These plans allow you to leave your pension invested but draw an income from it. The capital should grow tax-free (providing you with a decent hedge against inflation) but your income will be subject to tax if it exceeds your personal allowance. When you die, remaining funds can be left to your beneficiaries - if you are younger than 75, this money is paid tax-free, 75 or over and tax would only be liable on the income generated from the capital.
Find out everything you need to know about the new pension freedoms and how to plan ahead for the retirement you deserve withthe new issue of How to Retire in Style. The magazine is available to buy now from all leading newsagents, priced at £4.99. It can also be ordered online here for £6 including postage and packing.
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.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
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.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
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.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).