This month, the new Pension Freedom rules came into force. Now, if you are over the age of 55 you have the freedom to take control of your pension and retirement income. In other words, you can withdraw your entire pension fund and blow it on a cruise of you wish. Generally, this is great news, especially for younger people, who have been somewhat reluctant to save into a pension because they thought it would be tied up for a long period of time. This is no longer a problem. Freedom is here! But with freedom comes responsibility. Here are 5 things to think about.
1: You might get taxed! The next few months could prove to be highly lucrative for HMRC because the tax rules surrounding Pension Freedom are widely misunderstood and many people are expected to face hefty tax bills when they cash in their pensions. Only the first 25% of what you take out of your pension is tax free. You’ll pay income tax on the remainder. This means that if someone earning say £26,000 a year had £100,000 in their pension and withdrew it all, they would have to pay £25,000 in income tax.
2: Your money might run out! The primary purpose of a pension is to provide you with an income in old age. Before the reforms, there was little choice. Yes, you could take 25% out free of tax, but the remainder would typically be used to purchase an annuity, which was designed to provide you with an income for the rest of your life. The trouble is, with interest rates being at an all-time low annuity rates have been poor. Hence annuities have become something of a dirty word. People no longer have to buy an annuity, which means ad hoc lumps of money can be taken from a pension, leaving the old person vulnerable to running out of money completely.
3: You might be susceptible to to bad decisions! We have seen people take money out of their stock market linked pension funds to invest in Cash ISAs, because they didn’t understand how their pension money was being invested. While they may be lower risk, the growth rates on Cash ISAs have been pitiful. On average, Cash ISAs returned 1.53% according to Moneyfacts. In contrast, the average stock market investment returned 6% in the same period. By making such a decision, you could be stalling your investment growth potential.
4: You might get scammed! I can see the headlines in the newspaper already; “Thousands withdraw pension funds to invest in Peruvian Paradise Property Scam.” People can be so stupid with their money! I was reading about an elderly widower from Liverpool who fell in love with a young European lady on the internet. Over a period of 2 years in which several emails and photos were exchanged, he drained his life savings to fund her education, her mother’s medical bills, buy her father a BMW and fund several trips for her to come to the UK – none of which materialised. He eventually found out that the whole thing had been fabricated by a young man working out of an internet café in Nigeria! Which leads me onto my next point:
5: You adviser may stop you! With freedom comes responsibility and the government has quite rightly stipulated that people seek advice from a financial adviser before making a life changing decision. Ultimately, a financial adviser could refuse to help you withdraw your pension fund if they felt it was not in your best interest. This is because they would be held responsible for the advice. That in itself begs the question whether indeed Pension Freedom is freedom in the traditional sense.
Akwasi Duodu, Independent Financial Consultant, Sterling & Law