Comparing pension freedom predictions to the reality
The Treasury recently released much anticipated statistics revealing that 230,000 people have taken £4.3bn out of their pension pots, since the new pension freedom rules were introduced just over a year ago. These figures include those who are taking flexible incomes from their savings, and buying annuities.
Unfortunately, it is not possible to break down this overall figure and align exact withdrawals to specific months in order to gain a comprehensive understanding of time related trends. This is because until April 2016 it was not compulsory for pension funds to tell HMRC exactly when cash was being withdrawn. We can, however, deduce from this figure that the reality of pension freedom has seen more individuals merely access their pension pot, rather than cash it in in its entirety than originally predicted in a 2014 poll by Ipsos Mori.
This research forecast that over 200,000 people – one in eight of those eligible – were planning to cash in their entire pension pots. A more in-depth breakdown of this research revealed that 12% were planning to spend the money on DIY, while 14% had decided to help their children. Some 13% said they would use some of their retirement savings to pay off debts while 23% said that they would save it.
The pensions freedom reality has proven pension savers to be far more cautious than initially predicted. Indeed, the great majority only cash in relatively small pots which represent a tiny proportion of all the money which could have been released. This is a good indication that pension savers are savvy to the simple fact that releasing the funds of an entire pension pot will carry significant financial penalties. Those considering such a move need to be aware that:
75% of withdrawals from a pension pot are still taxable.
If you take money out when you are still working or receiving other taxable income, you may pay unnecessary higher rate tax on your pension
You may find that you have compromised your ability to claim certain state benefits in the future.
Your maximum annual contribution to pension (annual allowance) drops from £40,000 to £10,000.
Any existing pension may not allow flexi-access drawdown so you may have to transfer to a plan that does.
Any existing plan may have guaranteed annuity rates which make staying put more attractive than you might have thought.
Any existing plan may levy significant exit charges, making a transfer out quite expensive.
With this in mind it needs to be understood that full pension pot access should only be considered in very specific, isolated cases following financial advice. Accessing a 25% tax free lump sum appears to be the favoured approach to the freedoms, but doing so comes with its own pitfalls and opportunities. A year of pensions freedom has illustrated that if used correctly, the rule changes can present tremendous financial planning opportunities and regulated financial advice will ensure that opportunities are not missed by consumers.