A year after the rules on pensions were relaxed, meaning those over 55 can cash in their entire pension pot, fears about mass withdrawals have not materialised. In fact, far from splashing out on fast cars and holidays, the evidence available suggests that, so far, most people have been making sensible decisions about their pension funds.
Analysis undertaken by pensions provider AJ Bell on its clients' withdrawal trends over the past year found full withdrawals made up just 1 per cent of all withdrawals and the majority - 77 per cent - of full withdrawals were less than £30,000 in value.
Tom McPhail, head of retirement policy at Hargreaves Lansdown, says his platform has seen similarly low withdrawals from its clients, with the average income withdrawal rate sitting at around 3.5 per cent.
"What's been encouraging is that most of the evidence suggests most people are making good decisions most of the time. You look at the levels of income withdrawals, the investment decisions people are making and their trading activity, and all of this suggests that they are being quite sensible," he says.
"But in the long term is this sustainable? Are problems going to manifest down the line?"
The potential problems Mr McPhail anticipates include the difficulties of navigating the numerous and complex choices now available as a result of the freedoms. These choices include whether to take an annuity, income drawdown, cash withdrawal (full or partial) or a combination of these options. There is also the question of when to access your pension and whether to use savings before drawing your pension.
Making the right choices in the lead-up to and at the point of retirement is no simple task and getting it wrong could be extremely costly. So it's not surprising that many people feel overwhelmed by the choice on offer. A survey by online investment services provider Willis Owen found one in two people agree pensions are too complex, while just one in 20 disagree. Even more concerning was that the research found the level of confusion actually increases among those who have financial products such as workplace pensions and self-invested personal pensions (Sipps).
Mr McPhail fears the complexity could have the knock-on effect of making some people more disengaged from planning their retirement, especially with new employer auto-enrolment schemes.
He says: "Auto-enrolment actually encourages disengagement because there's no necessity or imperative to find out what's going on."
There are very few 'set and forget' retirement investment options available, he argues, and as a result individuals are going to need to be more engaged with monitoring their pensions - including after retirement. They also need to build some flexibility into their funds from the outset to manage possible market underperformance.
"I think the message is that you do need to keep an eye on this, and understand what risks your fund managers are taking and the potential consequences for a significant market downturn," he says.
"Recently we've seen the market wobble and then stabilise a bit, but a proper economic downturn, a significant market shock and a surge in inflation are the kind of things that could catch people out quite rapidly. These are the kind of areas where unless you've bought an inflation-linked annuity with all your pension pot, you might still come a cropper."
Mike Fosberry, financial services director at accountancy and investment management firm Smith & Williamson, also says tackling disengagement about pensions is a pressing issue. He argues that this is especially true as increasing longevity means state benefits and pensions will come down in real terms in the future.
"The fact is people are going to face longer and longer retirement so they are going to need more money in their pot to be able to fund that," he says.
But he worries that the political uncertainty around pensions may put people off saving as much towards their retirement because they do not know what kind of system will be in place when they retire.
He says: "We've now got to get stability into the pension system so that people can save consistently for the long term without the threat of change after change being imposed on them.
"How can [government] have a social contract with people to save for their retirement if they keep changing the rules every five minutes? It's a commitment to a very long-term savings programme and if you don't know with any certainty how you're going to be treated at the end of the day, why would you want to start saving now?"
Unfortunately there's not much you can do to manage this political uncertainty or the overly complex current pension arrangements, adds Mr Fosberry. All we can do as individuals, he says, is take stock of the options and tax relief currently available, and weigh up the advantages of investing in either pensions or an individual savings account (Isa).
How to navigate the pension freedoms
One way in which you can have more control is by recognising any charges and penalties associated with making changes to your pension arrangements.
"The first thing people who are looking to draw funds out of their pension pot need to do is look at whether they are paying any penalties for doing that," says Mr Fosberry. "Don't make any decisions without understanding all facts - that's a real priority."
Martin Tilley, director of technical services at Dentons Pension Management, agrees that the new freedoms have made pensions more complicated, but says there is lots of guidance available to help individuals make sense of their options. He recommends anyone aged 50 or over who is in a defined-contribution (DC) pension takes up the free 45-minute appointment they are entitled to with the government's Pension Wise service.
"Things aren't going to get any easier. Some people think that movement to Isas might make things easier, but actually that system is also getting more complicated," he says.
In addition to seeking guidance to help you narrow down your options and avoid making costly errors, Mr Tilley suggests people watch out for a number of other pitfalls. These include getting caught out by income tax if you withdraw more than 25 per cent of your pension pot in one go or being stung by scammers cold-calling to offer you a 'free pension review'. In the latter case, many of these promoters will try to get you to invest in unregulated investments or cash in final-salary pensions.
It is inevitable, Mr Tilley says, that some people will make ill-thought-through decisions. However, his firm has been encouraged that only a handful of its clients have fully withdrawn their pension pots. Of this number, most individuals withdrew less than £100,000, although one withdrew a fund of more than £300,000 in one go. As a result, they faced a hefty tax bill of 45 per cent on anything above £150,000, which Mr Tilley says could have easily been avoided if the money was taken out in four tranches of about £80,000.
Despite the risks of poor decision-making, he believes that overall the new freedoms have generated more interest in pensions. He also encourages people to take advantage of some of the new opportunities the changes have thrown up, including the removal of death taxes on pensions, which make it easier to provide a legacy for your loved ones.
He says: "Because of the more generous benefits on death now it's actually better for wealthier pensioners to run down their personal assets and leave their pension assets alone. It was formerly a good idea to run down your pension as quickly as you could and leave your personal assets untouched. So we've actually seen some people reduce the level of income they've been taking from their pension."
Examples of pensions mistakes to avoid
| Mistake | How to avoid it |
|---|---|
| Not nominating your beneficiaries | This is easy to avoid but likely to be one of the most common mistakes. Everyone must make sure they have nominated their beneficiaries for their pension pot on death. If you don't, it may be that your fund can only be paid out to a non-dependent beneficiary as a lump sum, rather than as a regular income. If the death is over the age of 75, payment as a lump sum rather than income could create additional tax charges. |
| Transferring schemes when in ill health | Pension freedoms have led to an increase in pension transfers as people move into a plan that offers pension freedoms. However, if you make a transfer while in ill health and die within two years it could be that HM Revenue & Customs assesses your pension for inheritance tax. |
Source: AJ Bell
