John Lawson: The price of freedom and choice in pensions

So, Freedom and Choice Day has come and gone. What has happened so far and what can we expect next?

An initial rush of people taking cash had been expected. Those aged over 55 but under 60 who did not have access to the £30,000 total or £10,000 in three single pots trivial commutation limits were one source of demand. Everyone over 55 who wanted to take more than £30,000 as either a partial or full encashment was another.

However, those with their heart already set on taking cash have been a relatively small proportion of overall enquiries, the bulk of whom are not sure what to do with their savings. In addition to the normal wake-up packs, customers also receive risk warnings under the second line of defence rules and are being referred to financial advisers and Pension Wise to help them consider their options more carefully.

It will take two or three more months at least to see the emerging picture of what the vast majority of savers are ultimately choosing to do.

One of the most positive early signs is that a large proportion of savers have either taken or plan to take financial advice. Given the complexity of the choices, the impact on personal tax and the potential loss of means-tested benefits, this is good news. The cost of making the wrong choice, even for those with modest savings, can easily be measured in thousands of pounds rather than hundreds. Advisers can clearly add value here.

The following are some examples of particular areas where customers could do with some help.

Taking pensions as cash to invest in a bank account

It is clear that customers do not understand a pension is just a tax ring-fence. They are generally unaware that they can keep their savings in a bank account within their pension rather than having to move it outside. Cash Isas are available outside the pension ring-fence and, from April 2016, the first £1,000 of bank account interest (basic rate taxpayers) or the first £500 of bank account interest (higher rate taxpayers) will be tax-free. However, these tax-free concessions may not cover all of the cash a saver has, so keeping cash within a pension bank account may make good sense.

Timing of withdrawals

We have already seen customers insist on taking large withdrawals despite the severe tax consequences. Many of the people withdrawing are unaware of the higher rate tax threshold, loss of personal allowance from £100,000 of taxable income or the 45p tax band. Staggering withdrawals (including tax-free cash) over a number of tax years could save someone thousands.

Choosing the right method of withdrawal

There are now two main options for withdrawal: flexi-access drawdown and uncrystallised funds pension lump sum. Flexi-access is generally more suitable for those who expect to pay tax at a lower rate in the future, as it allows them to withdraw just their tax-free cash upfront and defer the taxable part until their highest marginal rate falls. Taking no more than their tax-free lump sum also preserves the annual allowance of £40,000.

Losing means-tested benefits

Taking money out of a pension could reduce or remove altogether entitlement to state benefits such as Pension Credit, Housing Benefit and Council Tax Reduction. Savings within a pension are disregarded in the calculation of entitlement of most means-tested benefits but, once taken out of the pension, that capital generates a notional income that can reduce or remove any entitlement. Understanding the impact of cashing in a pension fund on means-tested benefit entitlement is paramount before taking a cash lump sum or income.

The Government has produced basic guidance but advisers can also refer clients to Citizen’s Advice or Pension Wise if they do not want to provide advice in this area.

These are just some of the basic problems people are struggling with at the moment.

Negotiating these potential pitfalls is only the first step. Understanding the risk/return trade-offs between annuities and drawdown takes the complexity to a whole new level but advisers who show they can add value on the basics are sure to be trusted to help people manage more complex planning in the longer-term.

Source:  Money Marketing John Lawson Head of Pensions Policy at Aviva 20th May 2015

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