Pension freedom is great news for pensions – new rules make them more user-friendly, now industry needs to help customers benefit from the changes
by Dr. Ros Altmann
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Don’t be in a rush to take money out of a pension and suffer the tax consequences
I believe most people will be responsible with their money, I trust people
Pension Wise is there to help – make sure you use it 030 0330 1001
From today, April 6th 2015, the rules governing the UK pension system will change dramatically. I believe most people will be careful and use their pension savings wisely, to suit their own needs. Those who have been responsible enough to save for their retirement are unlikely to suddenly spend it all just because they can. They will want it there for later life. Indeed, these new freedoms – and the removal of the 55% pension tax on death – should mean more money coming into pensions and staying in pension funds for longer. That should mean less pensioner poverty in future.
Flexibility makes pensions more attractive: Instead of being one of the most inflexible pension systems in the world, the new rules enable pensions to be more user-friendly, making it much safer and more attractive to save in a pension fund.
Government won’t tell you what to do with your money – will trust you to know what’s best for your own circumstances: Whoever you are, you should – at least in theory – have control over your pension money, rather than the Government dictating what you must do with it. People much prefer to have control and flexibility. (In practice, many pension firms may not allow you the new freedoms and, although that is very disappointing, you should usually be able to move your money to another fund (although again your pension firm may penalise you for doing so).
Old restrictions being removed: The old rules meant that, unless you had huge (or very small) amounts of pension wealth, your pension money was locked in for life. Once you had put the money in, you were severely restricted in the way you could take it out. And any money left in your pension fund when you died was taxed at 55%, so you really didn’t want to have too much in there. This is all changing now.
Not forced to buy particular insurance products, can keep money for later life and pass on what’s left tax-free: You will not be forced to buy a specific product with your pension and any money left when you pass away can go to your loved ones tax-free – no inheritance tax and no income tax – as a pension for future generations (if you die after age 75 they will only pay tax from next year if they take the money out). These new rules make pensions far more attractive than ever before, and should mean more people saving more money in pensions, which can support them better in later life.
Pension income from annuities has fallen sharply – now people won’t be forced to buy, can wait: Under the previous inflexible system, the law said that, as soon as you wanted to take even a tiny sum out of your pension fund in later life, you had to ‘secure an income’ which, for most people, effectively meant you had to buy an insurance product called an annuity. This meant an insurance company took your pension fund and promised to pay you a guaranteed amount of income for the rest of your life. That amount was usually fixed for ever, with no chance to change it and the amount of income the insurer promised to pay you was determined by the interest rates it could earn on your money and how many years it was expecting to have to pay you for (i.e. how long you were expected to live). As interest rates fell and life expectancy forecasts increased the amount of pension income you received from an annuity declined sharply, leaving many people disappointed with their pension. Now they have a chance to wait longer before deciding what to do, leave the money invested and either hope that interest rates will rise again, or that investment returns will allow the fund to grow and eventually get more pension. Many people were buying annuities at much too young an age and it is much better to wait, especially if you have other pensions or are still working.
New rules give same flexibility to everyone as were already enjoyed by wealthiest – that’s fair: If you had a pension fund worth around £100,000 or more, you were allowed, under the old rules, to put your money into an income drawdown product, but even with this product, which let you keep your money invested rather than locking it all into an annuity, the Government imposed severe restrictions on how much of your fund you could take out each year. Those with the very largest pensions (total pension income over £20,000 a year) were allowed to take all their fund out as cash if they wanted to even in the old system. Now the same rules apply to those with smaller funds as were already allowed to the wealthiest. I believe that is fair. Why should the Government assume that those who have less money are not capable of making good decisions? Everyone should be trusted to spend their pension money as suits them best.
Unfortunately, many pension firms or company schemes won’t let you have the new freedoms – they’ve been slow to act: Not all pension companies or company pension schemes are going to allow you the freedom the law says you can have. Although some companies have geared up to serve their customers, many will not let you just take your money out if you want to, they may force you to pay penalties to switch to another firm. They claim the reforms have been introduced too quickly and they haven’t had time to adjust. Certainly the Regulator has been slow to clarify the precise requirements, however the companies have known about the freedoms for 13 months. Most industries have to adjust to new circumstances rapidly, they can’t expect to the world to stand still for them. For example, when oil prices halved in a month, companies had to adjust. Many pension firms have not invested sufficiently in customer service and new systems that are needed to be adaptable to the modern financial world.
Fears of people cashing-in pensions and falling back on means-testing are overdone due to New State Pension reforms: Some have commented on fears that people will simply cash in their pension fund and ‘throw themselves back on the state’ leaving taxpayers to pick up the bill for more means-tested benefits. This fear is hugely exaggerated in my view, particularly in light of the radical reforms to the state pension which start in April 2016. In the previous system, nearly half of pensioners had income below the Pension Credit means-testing level so any private income you had (whether from other pensions or from continuing employment) was penalised in the means-test, meaning state pensions undermined private pensions. The New State Pension aims to ensure most people’s pension income is above the £150 or so means-tested Pension Credit level, so any private income should no longer be penalised as before. There will be a transition period but for younger people the aim is that state pensions provide a safe base on which private pensions can be built, without penalty. In other words, in later life, if you cash-in all your pension savings, you will just have to live on the state pension of around £20 a day, and should not expect more from taxpayers than someone who has kept their pension savings in tact to see them through retirement.
Fears of scams are valid but fraudsters have always been there, people must be wary: Clearly there are risks that people will fall prey to scammers or fraudsters, which is why they need to be warned clearly about the risks. If you are called, texted, emailed or written to by a firm you don’t know, offering to invest your pension, don’t do it! Check them out carefully, call Pension Wise or call the police if you think you are being scammed. The Regulator should be introducing a nationwide campaign to warn people of such frauds and setting up a hotline to report any suspicious activity.
Pension Wise guidance vital to help people with the new options available – already has thousands of appointments: The Government’s new, free impartial information and guidance service starts today too. It is there to help pension savers with their new freedoms. In the past, most people could not really do much as they were forced into an annuity anyway, but now with more flexibility, it is vital they understand what is going on. So Pension Wise guidance service has a really important part to play in helping people understand what their options might be under the new system. In particular, the advantages of leaving money in your pension fund and the tax implications of taking money out are two of the most important issues to understand. Call Pension Wise on 030 0330 1001 to discuss these options and your situation. It should help and you can have an appointment on the phone, face to face or just use the online information guides.
Seeing a financial adviser is the best option if you can – paying for this can save you money: Most people would pay a lawyer or an accountant to help them with a complex legal or tax matter. Pensions are just as important and it will usually be worth considering paying for a specialist expert to advise you on what’s best to do with your pension. Paying a financial adviser can save you money in future and don’t think that using an on-line information and broking service will mean you don’t pay anything. If you buy a product, you may well end up paying quite a bit in commission – indeed even more than if you used an adviser, so don’t be put off just by having to pay a fee. Think carefully about getting the best chance to use your pension wisely.
Much better than the old inflexible system – and much fairer: The new pension system is much better, especially for people with average sized pension funds, than the previous regime. Rather than being forced to buy an annuity, which may have paid only a few pounds a week and which normally had no inflation linking and no pension for a partner, you should now be free to take some out and leave the rest invested (which you could not do before) or spend it on repaying debt. If you have other pensions, you could use one of your funds for important spending, rather than having to give it to an insurer in exchange for just a small weekly sum. You can use your pension savings to suit your needs, rather than those of the pension providers.
Today is not the day you must do anything – significant benefits of doing nothing with your fund: You may also need help to understand the benefits of doing nothing for now. Making a proper financial plan can clarify whether you should leave your money invested, spend other funds, rely on other pensions or work for a while longer. You can help yourself (or work with a financial adviser) to avoid spending your pension money too soon. The longer you leave it, the more potential for growth. After all, you’ve saved hard for a pension that can see you through retirement, so you probably need it there for later life. If you need the money for unexpected spending, or perhaps for health or care needs, once you have spent it, it won’t be there later, but keeping it longer means you can call on it when you really need it.
Triple tax whammy of taking money out of pension fund too soon: Make sure you understand the tax implications of taking your money out of your pension fund. By spending your pension money too soon, or taking cash out to use for other investments, you can face a triple tax hit.
- You lose the tax benefits of keeping the money in a pension (no income tax, no CGT and no inheritance tax).
- Any money you take out (beyond your 25% tax-free cash) will be taxed as if you had earned that sum during that tax year – if it is a large amount you could lose 45% in tax
- Any new investment you make will be taxed, such as a buy to let property on which you will have to pay income tax on the rent and capital gains tax on any gains, as well as inheritance tax when you pass away.
So don’t rush into anything. This is just the first day of the new freedoms – there is plenty of time to make decisions and make sure you do the right thing with your hard-earned savings.