The Chancellor's pension changes are both wonderful and horrid
In this week’s Budget, the Chancellor announced the most sweeping changes to pensions for years. From 2015, everyone will have the option to access their cash without having to buy an annuity – the product you buy to convert a pension pot into a regular income for the rest of your life. I am completely torn over this policy. There’s no middle ground, it’s either wonderful or horrid.
In a nutshell, from 2015, at the age of 55 you’ll be able to take 25% of your pension savings as a tax-free lump sum and can then access the rest when you need it, but paying standard income tax when you draw that money out.
For example, at current rates, if you had £200,000, you could take £50,000 out tax-free at 55 (or later), and then if you chose to take the remaining £150,000 out, paying tax on it as if it was income. For a full explanation, see the Pension changes news story.
That wouldn’t be so clever, as it’d push you into the 40% tax band and you’d lose a good chunk of the money (or if you had other income, it’d be the 45% tax band). So instead, what you’d likely do if you wanted to get all the cash out and minimise your tax liability, is withdraw just up to the 40% band (c.£45,000) each year until you’d taken it all.
It’s wonderful because… For savvy, financially responsible individuals it allows you the complete freedom to use your pension fund in the best way possible. This could be to repay your mortgage, or it could be to clear expensive credit card debts.
This has long been the complaint about annuities – it locks you into a product that’s poor in comparison to the other alternatives you can choose to use for your money.
You could choose, as I suspect (too) many will, to invest it in a buy-to-let property to hopefully generate capital growth or income. Done right, this is far better than the current arrangements.
It’s horrid because… Many people are financially uncertain and confused. Already in the annuity market, a huge 60% of people just grab their pension firm’s annuity offer, rather than finding the best rates. As you then lose out each year for the rest of your life, the cost of this mistake can be huge, eg, £11,000 lost on a £100,000 annuity purchase for someone living 25 years.
So allow me a good old fashioned bit of paternalism; how do we expect the same people to make the right choice when there are even more options and choices? Never mind the not insignificant group of people struggling with mental health issues or the onset of dementia.
To make a decent decision, you need to know roughly how long you are likely to live at retirement and what the effective returns are on your money.
While financial freedom of choice is a great boon for the savvy, for the mass who are typically scared of finance, as well as making the wrong financial decision there’s a further dual worry. Some will splurge too soon and leave themselves with nowt for their dotage. But just as many will nervously keep it in their current account, never spending and depriving themselves of the benefit out of over caution.
This juxtaposition is one I am wrestling with. The Chancellor has said he wanted to give everyone access to independent advice to help them decide. This is a great idea – I always suggest using an independent financial adviser before taking out an annuity – yet most IFAs won’t touch people with small pension pots (that’s not an attack, just a fact, the structure doesn’t let them run their businesses if they do).
However, to combat this, the Chancellor has said he’ll put aside £20m over the next couple of years for face-to-face advice. Though we’ve scant details on what that really means. Yet on a back-of-an envelope calculation, with infrastructure costs we will be lucky if we’ll get 200 advisers working on this – that’ll hardly touch the sides.
So I’m still wrestling. Many of the comments from members of the public I’ve read on this are in favour. Then again, to comment on this means you understand it, which means you are in the group of financially savvy who will gain. The voices of those who don’t understand it are far quieter – so it’s tough to judge the real public view.
The remaining question is: how do we enable pension freedom for those who want it, while protecting those who may misunderstand how to plan for themselves? I’d welcome your views…
