There are two harsh facts of life with pensions: if you’re young – say below 50 – you’re probably not saving enough for the lifestyle you’d like later in life; and if you’re the other side of 50 you’re probably now realising that you’ve not saved enough, and that pensions were about more than securing tax relief on contributions.
This latter situation has been made worse by the plunge in interest rates, which dictate returns on pensions, and poor annuity rates when a pension pot is converted into a lifetime income. Some help is at hand, however, in the shape of a change to pension rules from next April, and these do represent a genuine pension revolution that is poorly understood.
Under current rules 25% of a pension pot can be taken tax-free at any age over 55. Beyond that payments could be drawn down, subject to normal income tax. The requirement that pensions had to be converted into an annuity after 75 has already been dropped.
Because people have greater flexibility – and from next April will have even more – the annuity market is disappearing. This is putting businesses that did very well from annuities under pressure to come up with alternative products. Where this all goes will only become clear after next April. Then people over 55 will be free to draw down their entire pension pot, if they wish, with no restrictions, and a quarter will still be tax-free. People can use it as an investment, or they can splash the lot how they wish, from a Ferrari to a yacht. That’s what the headlines have been about, but in reality most pension pots are below £40,000 and the biggest use made of them in Australia, where there’s been pension freedom for some time, has been for a luxury holiday or a new kitchen.
This will be one of the successes of the coalition Government for older savers who’ve been hit by low interest rates. It really is about genuine pension freedom. People can draw down from their pension as they wish, while it goes on earning a return; they can opt to take an annuity, or they can take the lot and do as they wish. It really is as simple as that, and the decision will be linked in most cases to tax considerations and personal spending plans.
Remember, however, that the new rules do not apply until next April. Until then choices are limited to draw down or annuity and most people are delaying pension decisions.
It will be interesting to see what happens to the annuity market. Some people still like the security these offer, but returns have been poor. One certainty is the need to shop around, since the annuity on offer from your pension provider will be significantly worse than what is available on the open market.
There are various suggestions about how best to tailor your pension. One is that the best return will come from exhausting it in a tax efficient way before using your state pension, since it offers a better return if you delay taking it. These are, however, complex decisions – and the big unknown is how long you will live and need a pension income. This is why annuity rates are better for smokers and those in less than perfect health.
General advice is available from the Pensions Advice Line, but because of the complexities independent, paid for advice will be better. If you pay for advice it must be independent, and crucially the adviser should not receive commission for any of the products.
As to not contributing enough to a pension, if you’re below 50, current advice is that there is a £97 a week gap between contributions and the income people expect when they retire.