The new pension freedoms are a success but employees still need personal financial advice to reap the optimum rewards.
Voltaire famously warned that “It is difficult to free fools from the chains they revere,” and many experts were certainly concerned that the government’s new pension freedoms introduced in April 2015 would be abused by horrendous numbers of foolish individuals.
The changes (scheme rules permitting) can enable those aged at least 55 with defined contribution pension schemes to effectively dip into their pension pots as and when they like in a similar way to a deposit account.
It was therefore feared this could result in people blowing the contents on luxurious holidays, fancy cars and other irresponsible expenditure and subsequently finding they did not have enough left for retirement.
Under the old regime, when most people purchased an annuity paying a fixed income for life, this did not happen. Even if they spent the income unwisely, they could not access the remaining capital.
Fortunately, however, these fears have proved largely groundless to date, and the way that withdrawals are taxed has provided an important safety mechanism in this respect. Although savers can access up to 25% of their pension fund as a tax-free lump sum, further withdrawals are subject to Income Tax at the individual’s marginal rate.
This means that anyone making a withdrawal that raises their annual income above the higher rate tax threshold (currently £50,000) becomes liable to 40% tax.
Recent HMRC statistics show that over £25 billion has been withdrawn since April 2015 and confirm a consistent rising trend. 284,000 people withdrew £2,060 million between them in Q1 of 2019 – compared to 222,000 people withdrawing £1,700 million in Q1 of 2018 and 74,000 people withdrawing £820 million in Q1 of 2016.
There is also a consistent trend of increased withdrawals in the second quarter of each year followed by lower withdrawals in the other remaining quarters, suggesting that people are waiting to access money tax-efficiently at the beginning of the new tax year.
Whilst there are no official figures to show what all these withdrawals have been spent on, the feedback from clients is that it has tended to be used largely for purposes that could be considered necessary and sensible, such as paying off debt before retirement, funding retraining or business start-ups or helping loved ones pay for medical treatment or care.
The consensus view is very much that the new freedoms have so far proved a ‘win win’, giving consumers greater control over their savings and providing the government with much-needed additional tax revenue.
Nevertheless, it is still early days and there is clearly a possibility that some who have already made withdrawals could carry on doing so at a rate that doesn’t leave them with enough to fund a comfortable retirement.
Others could be failing to maximise the potential size of their pension fund by making the wrong investment decisions. Some highly risk-averse people, for example, leave too much in very low-yielding assets – making them vulnerable to the impact of inflation.
Additionally, many simply aren‘t saving enough in the first place. In particular, they often mistakenly believe that the 8% overall mandatory minimum auto enrolment contribution level will be enough to meet their needs.
If employees find themselves unable to retire when they originally intended it is not only bad news for them but it can also play havoc with their employer’s succession planning.
So, employers should consider giving them access to one-to-one face-to-face regulated personal financial advice.
Chase de Vere can provide a worthwhile level of such advice at highly affordable rates to discuss issues like retirement objectives, investment decision making and contribution levels. If the individual concerned has not yet reached retirement, it may be that the employer might want to pay for this or at least split the costs with the employee.
But even if employees are required to foot the entire bill themselves, they should still be grateful that the employer has been able to refer them to a suitably vetted firm of financial advisers.
The Financial Conduct Authority does not regulate tax advice.
The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.