Pensioners more likely to invest than blow annuities

Greater pension freedom will be popular, and that says something, but greater policy certainty would help too

There won’t be that many pensioners blowing their investment on luxury cars (Alamy)

Freedom is also responsibility. If it is hard to predict the short-term impact of the freedom pensioners now have to cash in annuities, it is harder still to gauge what will happen in the longer term.

But one thing is clear. Almost all private-sector workers need to save more for their pensions, so the test of this clutch of legislative changes will be whether they encourage people to do so.

When interest rates were higher and life expectancy lower, there was a reasonable case to be made in forcing people aged 75 to buy an annuity.

If you accept that the function of a pension pot is to provide a good standard of living in retirement and not to build up wealth that can be passed on to the rest of the family, then transferring the uncertainty over the period you would live to a third party made sense. The provider could match your actuarially likely lifespan to government stock of the appropriate duration. High interest rates on gilts gave a good return, while the availability of indexed gilts meant that the provider could offer index-linked pensions too.

All this has changed. Now annuities give a very poor return and it is impossible for providers to give a better one, with 10-year gilts yielding just 1.8 per cent, less than target inflation. A portfolio of shares in large companies should yield 4 per cent with some capital protection, but regulation gives them no incentive to switch.

Whether people do cash in their annuities will depend on their personal situation as well as their inclination. My guess would be that quite a large proportion will.

But rather than blowing it on a Lamborghini they will be much more likely to invest it themselves in something that gives a better return, or perhaps pass the pot to their children to help them buy a house. If that proves right, then at the margin there will be less money going into gilts and more into other assets. Given that yields on government stock are the lowest they have ever been, and we have a run of data lasting more than 300 years, this must make sense.

The most-interesting question of all is what these proposed changes will do to longer-term saving habits.

People in the private sector do not save enough for their pensions. The defined benefit or final-salary system has been undermined (some would say destroyed) by a combination of government tax raids, increased regulation, and a 15-year period when equities went sideways.

One result is pension inequity. The Institute for Fiscal Studies noted this week that 89 per cent of public-sector employees are in pension schemes whereas only 49 per cent of private-sector employees were. And 83 per cent of public-sector pensioners had a defined-benefit pension scheme against only 9 per cent in the private sector. The growing proportion of workers in the private sector, including the rising number of self-employed, make this contrast even starker.

Will the changes in pension rules encourage private-sector workers to put more into a pension in the knowledge that they will not be herded into annuities aged 75? Rationally the answer should be yes. But pensions are not only confusing and complicated. The rules keep changing and will change again.

At the moment, under the new legislation, it seems that a pension pot can be passed onto children free of inheritance tax. But that concession could be shut, and shut without notice.

Greater pension freedom will be popular, and that says something. Greater policy certainty would help too.

New freedoms: how they work

What are the new pension freedoms?

From today anyone aged 55 or over will be allowed to take the cash out of their pension pot and do what they like with it. Or, to be strictly accurate, anyone with a defined benefit pension scheme may have the opportunity to get their cash if their pension provider has set up the necessary procedures.

Doesn’t my pension provider have to give me my money?

Not all pension companies, and not all pension schemes, will offer all the freedoms. Some may offer some options, while others may not offer any of the new flexibility to take your cash out. If that’s the case and you really want to get your cash, you may need to transfer your retirement savings to another company to access your pot. But you should be aware that if you do this there could be penalties, which would eat into your savings.

Hmm, doesn’t sound as easy as I expected.

It’s not. The City Watchdog is aware of the problems and admitted that, faced with “the most fundamental changes to pension policy we have seen in over a generation”, it will be forced to spend much of the next few months closely examining pension companies and how they deal with their customers. Financial Conduct Authority boss Martin Wheatley said: “We will be looking at how the market is working and how the industry is adapting to this change, and what it means for consumers.”

If I can get my cash, can I do whatever I like with it?

That’s the theory. But if you splash out on a holiday or fancy car, you could live to regret it.

But why shouldn’t I spend my money how I want?

Remind yourself why you built up the money in the first place. A pension is simply a planned savings scheme with a clearly defined aim: to ensure you have enough cash to last through your older years. If you take the cash and blow it, you won’t then have cash available to buy yourself an income for life. That could leave you living off the relatively meagre state pension. There are also massive tax implications.

Isn’t my pension cash tax-free?

Only a quarter of it, the rest attracts tax at your normal rate. That’s 40 per cent if you’re a higher rate taxpayer but even if you’re not, the money you draw will be added to your income and could very well push you into the 40 per cent tax bracket. There’s also the risk of being charged emergency tax on your cash, which could leave with the problem of trying to reclaim it from HMRC.

So what are my options?

The much-maligned annuities are becoming more attractive and could well be a good solution for you, providing as they do a guaranteed income for life. The unfair issue that an annuity died with the person is changing, and the annuities themselves are become more flexible – allowing you to alter them to meet your changing circumstances. You could avoid paying tax on your pension altogether by delaying taking it out until you stop working and then staging withdrawals so that you don’t fall foul of income tax demands.

It sounds very complicated.

It is, and that’s why it’s important not to rush a decision. Do so and you could end up making a costly mistake. The Pensions Minister Steve Webb pointed out last week that today is not a deadline, it’s just the start of the new freedoms. Delaying a decision until the autumn will give you more time to consider your options and, by then, there are likely to be many more options offered by different pension firms. However don’t think you have to take the retirement income solution offered by your own pension company. You could potentially do much better by switching companies.

What if I want advice now?

Go to the Government’s PensionWise service. Visit pensionwise.gov.uk or call 030 0330 1001, or contact Citizens Advice to arrange a face-to-face session.

What shouldn’t I do?

Fall victim to a pension scammer. Jamie Jenkins of Standard Life warns: “The biggest risk in the new pension freedoms is scammers. The worst thing that could happen to anyone under the new freedoms is that they take all their money out and hand it to someone who is scamming them.”

How can you spot the scammers?

They usually cold-call prospective victims. So if you get an unexpected call offering help with unlocking your pension, put the phone down!

SIMON READ

Personal Finance Editor