Freedoms come at a price, and it can be steep, says Jeff Salway
Retirees with modest savings pots should be given more protection against the pitfalls of the pension ‘freedoms’ after new evidence emerged of people suffering unexpected losses.
That was the call in the wake of a Citizens Advice report which found that many people taking advantage of the new rules had lost savings to shock tax charges. It also revealed that an alarming number of savers were emptying their pension pots only to leave all the cash in a bank account.
The changes that took effect on 6 April 2015 allowed people in defined contribution (DC) schemes to unlock their entire pension pot from the age of 55 without incurring punitive tax charges. The main concerns until now have been around scams, the risk of pension savings being exhausted prematurely and the impact of market volatility on drawdown funds.
But the Citizens Advice study highlighted the particular dangers facing savers with relatively small pension pots.
It said 9 per cent of people using the freedoms had been hit by unexpected tax problems such as deductions. The figure rises to three in 10 of people who took their pension pot in one go, often wiping out large chunks of their savings.
Many people accessing their whole funds while still in work don’t realise that 75 per cent of the amount withdrawn will be added to their income and could be taxed at 40 per cent or more, said William Hunter, director of Edinburgh IFA Hunter Wealth Management.
“People are paying way too much tax unnecessarily by taking big lump sums, whereas spreading it over several years can reduce or eliminate the income tax payable to zero,” he said.
Others have seen their welfare payments cut as a result of taking pension cash, typically those with pension pots worth less than £20,000.
The report calls on the Financial Conduct Authority (FCA) to review whether risk warnings and signposting were sufficiently well targeted to reach more vulnerable consumers.
“Having cash savings in the bank over £6,000 (£10,000 for pensioners) will usually affect how much housing benefit you can get, for example,” said Hunter.
“Rather than take it all at once, taking withdrawals over a period of time can preserve their benefits. Bad planning can affect those with the least in their pots.”
Taking pension cash can also have consequences for debtors, pointed out Sharon Bell, head of StepChange Debt Charity Scotland.
“As well as the points highlighted in the report people have to be aware that should they withdraw funds after they become bankrupt or grant a trust deed, these funds would form part of their estate and may be ingathered by their trustee to pay their creditors.”
Citizens Advice also found that 29 per cent of people taking using the pension freedoms to access their pensions are then leaving that cash in a bank account. The proportion rises to 32 per cent of those with pension pots worth more than £100,000.
Low interest rates mean that in most cases that cash will lose value over time due to the effects of inflation.
“Taking cash from your pension and putting it in the bank is not wise because the money grows tax free in the pension, whereas it may not be tax free in the bank,” said Hunter.
The problem posed by the reforms is that people who would previously have bought an annuity with their savings are now faced with much more complex decisions. But those with funds of less than £50,000 or so are typically unable to access professional financial advice, due partly to an overhaul of investment advice in December 2012 under the retail distribution review.
Instead they rely on their pension provider and on Pension Wise, the government-backed guidance brand for which Citizens Advice provides the face-to-face service.
“Giving advice in this area is unprofitable and it’s also a disservice to charge what could be seen as high fees for those with little money and who can’t afford quality advice, as they need all the money they can get,” said Iain Wishart, of Wishart Wealth Management.
“More needs to be done by pension providers at the point the consumer is looking to potentially extract the funds from their pensions.”