Three bad ideas for your pension
Many of you will be pretty confused about what the new rules will mean for your pension fund. That's hardly surprising, since the details are not finalised yet. What we do know, however, is that most people over age 55 will have the opportunity to make new decisions about how, when or whether to take money from their fund.
Given all the uncertainties at the moment, there might be a temptation to make quick decisions but I would like to offer some words of caution to think very carefully before making any moves.
In particular, there is an interim regime in place now, which still restricts withdrawals, while the full freedoms won't come in until April 2015. As we don't know how all the details of the new regime will work, it could well be worth waiting for the government announcements on this in the coming months.
I'd like to suggest three things you might be tempted to do that could turn out to be a bad idea.
Withdrawing all the cash
The first is taking money out as cash straight away, if you don't really need to. After next April, the rules will change, but for now, if your total pension savings are worth under £30,000 or if you have three funds each valued under £10,000, the interim rules introduced following the Budget allow you to take all the money as cash. Should you be in a rush to cash your pension in?
Before you do, it is worth considering the significant tax benefits of pensions relative to money saved in other ways. If you take the money and run, you lose the tax benefits of being in a pension fund. Investment returns in your pension fund are tax free, but taking any more than the tax free lump sum means paying tax your marginal rate on the rest. If you are still working, you might lose 40% or 45% in tax, whereas if you take money out later, and in smaller amounts over time, you could pay far less tax in future.
Another potential tax advantage of not cashing the pension in is that if you have not taken any money out of your fund and you die before age 75 those assets can pass on tax-free. However, if you take even a small amount out of your fund, the balance will be taxed at 55%. The government is planning to change these tax rules so it might be worth waiting to see what the new tax structure will be.
Purchasing a lifetime annuity
Another course of action that might not be such a good idea is buying a lifetime annuity straight away. Of course annuities offer a secure income, but given the prospect of new freedoms, it is likely that providers will be developing new kinds of product that could be more suitable for you in future.
If you buy a standard annuity now, you will not be able to change it as they are irreversible. If better products come along, if rates rise, if your health changes, you will never be able to take advantage of better future deals. It will be worth taking financial advice before committing to a lifelong irreversible decision.
Failing to plan ahead
The third course of action that you may well regret later is failing to make a proper financial plan, if you haven't already done so. The new freedoms offer far more opportunities to plan your future income carefully.
Under the old regime, your pension choices were strictly limited - you could only cash in two pension funds worth under £2,000 each, or total pension savings worth under £18,000. In all other cases, taking any money out of a pension fund, meant you had to either buy an annuity, or income drawdown product.
After April 2015, you will have the chance to plan to withdraw as much or as little as you wish and to integrate your pension savings with your other sources of income and also plan to take out pension assets in the most tax-efficient way. So I would strongly suggest that you don't decide what to do with your pension savings without sitting down and making your own financial plan. Assess your future income, how much money you will want or need to spend, how much earned income you might have coming in and then how your pension fund or other assets can be used to fill the gap.
Until we have the full details of the new rules, think very carefully before making any hasty or irreversible decisions. These are likely to be really exciting times for pensions, with lots of new products being developed offering far more options to those who wait.
Jargon buster: the 'Portfolio Turnover Rate' (PTR)
Your pension fund charges may include what is called the 'Portfolio Turnover Rate' - what does this mean? It is a measure of how often the assets in your fund are bought and sold by the managers over the past year. The higher the PTR, the more trading transactions your fund manager has done during the year and the more he has changed the investments.
The more trading the fund does, the higher the costs you pay will be, because each transaction will incur a dealing charge. The calculation usually takes either the net total amount of new securities bought - or sold - divided by the total net asset value of the fund.
This article was written for our sister website Money Observer
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
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.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
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.