Pension rule changes enacted in April were a huge change for the industry which, until then, focused on helping individuals accumulate wealth whilst they worked and then offered them an income for life, known as an annuity, upon retirement. Admittedly some individuals invested and withdrew income instead, though even in these circumstances there were strict guidelines stipulating how much could be withdrawn and in what circumstances. It was definitely not available to all. From April 6th, however, pensioners were given full control over how and when they wished to take their life savings.
The latest report by the FCA (Financial Conduct Authority) was commissioned to highlight the impact that these recent new pension rules have had on savings. In the 3 months following the reforms 204,581 people accessed or fully encashed their retirement savings. This equates to over 1% of the entire population who are over 55 (based on the Office of National Statistics’ – ONS – latest figures) and can therefore access their pensions. Baring in mind this still does not account for all those with either annuities or final salary pension schemes already in payment, and therefore could not be counted in the report, then the scale is vast.
Further to the above 137 people entirely withdrew pensions exceeding £250,000 via uncrystalised pension fund lump sums (UPFLS) with a further 472 withdrawing similar amounts from drawdown pension schemes. This is of note because it results in sizeable tax bills. UPFLS is a method of pension withdrawal where 25% is tax free so this still leaves a minimum of £187,500 being taxable. For drawdown pensions the full amount is liable to income tax and therefore, in both instances, at least some of the pension will be taxable at a rate of £45,000 per £100,000.
Annuities appear to have fared equally as badly with a drop of 86% in comparison to the second quarter of 2013, which was prior to the governments intentions for pension freedoms being widely known.
The above paints an alarming picture of the effect new pension freedom rules have had. After all, pensions are meant to help people live a comfortable life in retirement by having a replacement income when their working life comes to an end. This is why the principles, if not necessarily the practice, behind annuities are a good idea.
The big problem with the report is that the information can easily get taken out of context. Let’s take the headline figure that over 200,000 people accessed or fully encashed their retirement savings. This appears a high figure until you start looking into the figures. Firstly, any partial encashments (27.7%) is what would naturally occur when someone is living off their retirement pot especially for lower amounts. Next, annuities and withdrawal of only the tax free lump sum are also included (14.3%) despite the fact that the former provides a retirement provision and the latter is what typically has always happened for those wishing to take drawdown. Then, if we also exclude full encashments of funds under £50,000 (56.4%), since this would only generate an income of under £135pm based on an annuity that increases with general living costs, then only a tiny fraction may be accessing their pension in a way that is detrimental to them.
What the report doesn’t highlight is what the funds are for. There is no proof based in this report that people are not looking after their own interests. For example, the highlighted withdrawn funds may be used for multiple purposes including reinvestment or paying off high interest debts. It would be interesting to find out where this money goes since pensions do offer a very favourable tax treatment, including avoiding tax on any gains, in comparison to investments held outside the pension wrapper.
Further points highlighted by the report include the sheer scale of pension contracts that would be required to be changed to access all the pension options now available under the new flexible pension freedom rules. To access either only the tax free lump sum or to partially encash a drawdown pension requires over 70% of policies to be changed though the majority of firms (82%) are planning to offer a new range of products that should help clients access their pension savings in the flexible manner allowed by the new regulations.