Have the pension freedoms introduced in April 2015 heralded an era of self-reliant retirement or left investors more confused than ever?
It’s almost seven years since the then chancellor, George Osborne, unveiled radical new plans for the UK’s defined contribution (DC) pension system. They were welcomed by frustrated consumers eager for greater freedom to manage their retirement savings – and greeted with dismay by some commentators, who feared many individuals would be worse off over the long term.
Those changes ended the requirement for most people at retirement to use their pension savings to buy an annuity that paid a guaranteed income for life. Instead, the onus was shifted to individual pension investors deciding whether to leave their money invested in the stock market, take lump sums, draw a regular income or cash the whole lot in.
In some respects, pension freedoms have brought real benefits. People are no longer obliged to commit their retirement savings to annuities paying historically paltry rates. They can leave their capital invested, generating returns while drawing an income from it.
Importantly, they can also adapt their retirement funding as they get older and/or if their circumstances change. For example, while annuities offer very poor value if you’re a healthy person in your 60s, rates improve significantly as you get older and your health (possibly) deteriorates. At this point in an investor’s life, they may be increasingly appealing as a secure, hassle-free source of income. Under the new regime, it’s straightforward to make the switch from income drawdown to annuity purchase at any stage.
Pension holders are also able to bequeath any remaining invested pension pot to whomever they want - in stark contrast to a conventional annuity, which ‘dies’ with its owner.
However, there are potentially serious drawbacks too. For a start, although a significant proportion of people retiring now will have final salary type pensions from previous jobs, which can provide some ‘core’ security, many simply don’t have large enough pension pots saved to generate a decent income. The Financial Conduct Authority reports that the average Defined Contribution (DC) pension pot, where benefits are not guaranteed, is worth £62,000. If that sum were invested to produce a 4% yield, it would produce an income of just £2,480 a year.
Unsurprisingly, many people feel insecure about their retirement prospects. New research from Abrdn¹ reveals that almost half of respondent retirees worry their retirement money will not last them out, while a large proportion are relying on non-pension sources to supplement their retirement income. The study finds a quarter are counting on inheritance and a third plan to downsize to boost their finances.
Other challenges have also emerged from the new regime. A large proportion of DC pension pots (admittedly 90% of which are worth less than £30,000) are cashed in, often to use for projects such as a home renovation or to help adult children with a deposit for a first home. These are not the frivolous Lamborghini purchases originally anticipated, but they do suggest people are not necessarily prioritising their long-term financial future.
Perhaps, more seriously, ordinary people without a great deal of investment knowledge are having to make big decisions about how to manage their retirement pot and ensure the savings last the rest of their lifetime – yet more than 40% of those starting to draw a regular income take no professional advice, according to the FCA’s latest retirement income market data.
Overall, only a third of those accessing their pension for the first time took professional advice, down 3% since the last review.
Particularly worryingly, the FCA’s latest figures show that 43% of regular income withdrawals were arranged at an annual rate of 8% or more of the pot value – twice the rate financial professionals would generally recommend if the aim was to run a sustainable retirement strategy.
The situation is made more complex by the shadow of longer-term calls on the cash. Even if you’re running your pension investments sensibly and with the help of a professional adviser, it’s increasingly likely that the capital may have to be used to help fund long-term care.
Clearly, the pension freedoms have opened the door to a more prosperous and flexible retirement for many people who would otherwise have been trapped by expensive, restrictive annuities.
But the bottom line is that this time of your life is arguably the single most important stage to seek professional advice. It could make a real meaningful difference to the quality of your later years.
Sources and Links
1 - Emailed press release, Advance Sight- Abrdn Research - Millions of retirees rely on inheritance and downsizing to fund retirement - 10.12.21
The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment decisions. Please also note the value of investments and the income you get from them may fall as well as rise and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.