It is five years since George Osborne stood up in the House of Commons and declared
Let me be clear. No one ever needs to buy an annuity again
This snippet, which was jumped upon by mainstream media, was ostensibly untrue as obligatory annuity purchase was effectively abolished in 2006, with the introduction of Alternatively Secured Pension – Drawdown for the over 75s – but for some reason this particular message resonated with the public.
What followed next – Pension Freedoms – was a wave of decisions by the general public which were, on average, detrimental. I believe there was more harm caused than good, as explained below, but that’s not to say the changes were not beneficial for some; for those who were well advised Pension Freedoms have largely been a resounding success.
I have said since the dawn of Pension Freedoms that the changes, which principally allows individuals unrestricted access to their pension funds, allowing them to take up to 25% tax free and the rest in as few or as many instalments as they wanted (as long as they pay the relevant tax) was more about raising revenues than they were about “freedom and choice”.
Problems have been exacerbated by individuals, who have been ill‑advised, transferring valuable guaranteed benefits from defined benefit schemes into private money purchase arrangements. This sees them lose the protections afforded to them by these safeguarded arrangements and requires them to make decisions over their investments and incur greater costs; as they pay for pension products, funds, and in many cases investment and planning advice. Perversely some have elected for protections or guarantees, at further cost, and usually far inferior to that provided by the sponsoring employer’s pension arrangements.
The five investment years that followed the announcement have been relatively benign, and whilst we have experienced some volatility in the last few months, most individuals have seen some of the kindest investment markets we have had for many years. Interest rates have been low and most investment markets have virtually unwaveringly increased in value.
At the same time though, our Regulator, the Financial Conduct Authority (FCA), said in a recent consultation paper that many individuals were unaware of where their money was invested post-Freedoms and many were holding too much cash. The same analysis showed that many individuals were in expensive, inflexible arrangements and that in actuality could not enjoy the full benefits of Pension Freedoms. One reason suggested for this was that no advice had been sought and it is rare that the scheme one accumulates benefits in should be the same arrangement from which benefits are drawn.
One of the potential benefits of Pension Freedoms, which has achieved a high level of coverage, is the ability to leave pension funds to chosen beneficiaries, potentially without inheritance tax. To say death benefits are tax free is not true, but often reported. This is because most individuals will expect to live beyond 75, and beyond that age whilst there may be no tax on the transfer of pension assets to the recipient they will pay tax at their marginal rate when they draw down, and this option is only available if the contract allows. Still many contracts have not been updated to the new rules and where a lump sum is left the tax charge may well be 45% – possibly more.
These improvements to death benefits allow the well advised to arrange their affairs more efficiently, but this has also led to some individuals transferring out of final salary schemes to potentially improve death benefits. The reality is many will see no such benefit: rules might change (they have changed virtually annually since 2006), the pension-holder may live long enough to drain the fund, or decide to annuitise in later life. If death benefits were a priority many individuals may simply be better purchasing life assurance to meet their needs).
FCA figures also show that many pots are fully withdrawn (over half) and more than half the pots were accessed at the earliest possible after (often age 55). With more restricted rules on what can be paid into a pension scheme once the pension income is accessed, this means many individuals have inadvertently (or possibly deliberately) reduced their future pension saving limits to 90% of what it may have been if they had had left their pension fund untouched.
One of the most common problems we see is an under estimation of how long a pension may need to last, with individuals underestimating their life expectancy, and also under estimating the time they will be in good health. Excessive withdrawals, especially after surrendering a defined benefit scheme leaves many exposed to the risk of running out of money.
Finally there have been a rise in a different type of scam: historically pension fund liberation or fraudulent investments was made more difficult due to the inaccessibility of the funds within the pension; now a fraudster can simply (and legitimately) have a victim withdraw their pension funds, and use the proceeds to invest in a dubious fashion.
Pension Freedoms are a classic example where the overall consequences have been on average negative, but in dealing with clients by the nature, who are not average, we see this as a significant positive: but it is unfortunate that the ill-advised or unadvised suffer at the detriment of those who engage with a competent Financial Planner.