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OPINION

Consequences of the ‘Lamborghini’ pension

Consequences of the ‘Lamborghini’ pension
March 28, 2014
Consequences of the ‘Lamborghini’ pension

I argued for unrestricted drawdown for all back in 2011 ('Why pensions are a bad deal', IC 14 October 2011). In that article, I pointed out that once the government introduces a flat rate state pension - now planned for April 2016 and probably worth £155 a week - that it claims is enough to live on, its 'moral hazard' argument for restriction of pensions income to stop investors spending all their pension pot and falling back on the state doesn't wash. So if a pensioner chooses to exhaust his fund by drawdown, and then live on the state pension alone, that is a personal choice, just as much as if he had saved money in the building society and then drawn it all out and spent it.

But should the chancellor have announced unrestricted drawdown for all in last week's Budget without consultation? No.

The announcement makes a nice distraction from the fact that the government is restricting the Lifetime Allowance on pensions to £1.25m from 6 April 2014. That's lots of doctors, public servants and head teachers with big tax bills in coming years. Anyone with a final salary pension of around £60,000 will be caught by the new limit.

 

UNINTENDED CONSEQUENCES

Every time the pension rules change, even when it's for the better, we wonder what the unintended consequences will be.

The obvious worry is now that the government has announced unrestricted drawdown from April 2015, people will have the choice to (as highlighted by Pensions minister Steve Webb) blow their pensions on Lamborghini sports cars. Some may do exactly this. Plus, there will be many unsavoury 'investment' companies and schemes that will be happy to relieve consumers of their pension pots when the time comes. But if they used a private sector pension over 30 years, they may have already paid for their fund manager to buy a Lamborghini - a matter the government is yet to address.

The vast majority won't want to pay a 40 per cent tax bill on income taken to spend on the Lamborghini - or whatever else they could buy by taking all their pension out in one go. The withdrawal is taxable at your marginal rate (apart from 25 per cent which remains tax-free) and higher-rate income tax kicks in at £41,450.

You can minimise the tax you pay by staggering withdrawals, and leaving something for your old age. Nobody really wants their pension to expire before they do. That's why most people bought annuities. Oh, yes, the annuities industry that the chancellor may have wiped out by his Budget speech, according to many commentators. The annuities market is far from perfect and certainly needs a thorough shake up, but tearing it down completely is not the answer. Let's hope the annuity industry manages to revive itself by innovation, transparency and better rates. Deloitte points out there is no requirement to buy annuities in the US, for example, but the market is huge and $220bn (£133bn) of annuities was written in 2012.

Symponia, the national membership organisation for care fees planning and later-life advisers, has warned that an end to annuities could see elderly people fall foul of the little-known 'Deliberate Deprivation rule' at the point of funding care. They say that a person who spends the majority of their pension pot while healthy in their 60s and 70s but then finds they have no money to fund care bills in their 80s and 90s could be guilty of deprivation. That's a big issue that would have been worth exploring via a consultation, Mr Osborne.

But staying focused on the positive, people previously put off by the inflexibility of pensions rules will find them more attractive. John Fox, managing director of Liberty Sipp, says: "One of the principal problems of previous pension regimes is that people have felt that the moment they invest money in a pension, it stops being their money. It feels like they're giving it away.

"At a stroke, these changes should remove that psychological hurdle. Handled right, they could be a hugely liberating force for the pensions industry - as they should encourage more people to start saving for the future. It's empowering pension savers rather than patronising them."

When more people start drawing their income directly from their pensions, there is a huge opportunity for the income drawdown industry to improve communications, innovate with new investment solutions generating secure income and reduce administration costs and advice charges.

 

ACTION POINTS

There are a couple of key action points regarding the Budget 2014 pension changes that I would like to highlight.

1. Anyone under age 43 will find that the minimum age at which you can take your private pension is going to rise. It will rise from the current minimum age of 55 to 57 in 2028, and then in line with state pension age rises which are linked to rising life expectancy. Effectively, it will always be 10 years before your state pension age.

If you were planning to retire earlier than 57, you will need to make other arrangements for the early retirement years, for example, by investing in an individual savings account (Isa). You won't get up-front tax relief on your contributions to an Isa, but you can withdraw an income from an Isa free of tax.

2. Three-quarters of pension default funds are invested in 'lifestyle' strategies, according to Hargreaves Lansdown, which are designed for people who buy an annuity. These 'lifestyle' strategies move people into bonds as they approach retirement, in the expectation they will buy an annuity. Absolutely everybody who is invested in a default fund in their company pension scheme should take a close look at it as the fund may no longer be fit for purpose. If you're going to carrying on investing for 30 years after retirement, you probably want to reach retirement with a healthy portion of equities in your portfolio.