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Reasons not to use pension freedoms

Prior to 6 April, financial advisers would usually tell investors to exhaust a pension pot where possible before drawing on other assets such as money held in individual savings accounts (Isas), or taxable investment accounts.

The reason for this was the punitive death taxes on any money left in a pension. But now these death taxes have been removed from the pensions regime, pensions have become the most tax-efficient place to keep your money. So for many well-off investors who have other sources of income, the pension should be left alone as long as possible.

We have seen examples of several investors who, like this one, are keeping their Isa as a reserve account in case they need an expensive stay in a care home. If they don't need care then the Isa money is to be left to their children. In some instances these investors were drawing down as much income from their pension as possible.

However, following the pension freedoms, this strategy might not make sense in tax terms. If an investor has a house that is worth more than the inheritance tax nil-rate band of £325,000 (£650,000 for a couple) any money left in their Isa will be subject to 40 per cent inheritance tax. By contrast, pension monies can be passed down to children free of inheritance tax.

If you have substantial assets and several sources of income, good tax planning may be more valuable than good management of your investments.

The problem is where to get good and accurate tax advice. There's been plenty of fuss over the introduction of low level pension guidance services such as Pensionwise and pension predators out to persuade you to pump your pension money into dodgy investments. However, you may be surprised to hear that there is no actual regulatory obligation on professional financial advisers to pass specific exams that show they understand the new pension freedoms.

Only after the pension reforms started, did the Chartered Insurance Institute launch a new exam to allow independent financial advisers "to bridge their current qualifications to comply with the latest pension reforms". The paper is called R08 and the first exams will take place in August 2015.

Until then, you have to rely on a financial adviser's professional obligation to keep abreast of pension reforms. The Financial Conduct Authority says that advisers are required to undertake a minimum of 35 hours continuing professional development a year. Also, firms should ensure that their employees are maintaining their competence, including with regards to changes to products, legislation and regulation.

If you have a final-salary pension in your income mix then tread carefully. Although transferring out to take advantage of the pension freedoms is something many will consider, many advisers are giving blanket advice that you should stay in your scheme whatever your circumstances. Lloyds Private Banking says that, for compliance reasons, they will not advise anyone to leave a final-salary scheme, even though they admit that it might make sense in a few circumstances, such as ill health.

Here are five questions to ask a potential adviser to assess if their knowledge is up to date on the pension reforms:

■ Drawdown or uncrystallised funds pension lump sum, which is best?

■ Are annuities taxed in the same way as drawdown post age 75?

■ Are there any changes on the recycling rules relating to tax-free cash?

■ Should I worry about the £1m lifetime pensions allowance?

■ What further changes to pensions legislation could happen? Would I be affected?

 

You can read our in-depth feature on the pension freedoms here.