Take care with pension funds, says Derek Stewart
Thousands of unwitting investors could be on the verge of making poor decisions pn pensions when a new law comes into effect next year. From April 2015, savers aged 55+ will be able to access the whole of their pension pot – the UK government estimates 400,000 people could benefit from the change.
The new legislation will allow individuals to withdraw their entire pension pot, with 25 per cent available tax free and the remainder subject to income tax at marginal rates.
The UK government thinks everyone has the right to decide what to do with their money, but there are risks – some may choose to spend it on the holiday of a lifetime, but will suffer in the long term when their pension runs out. Some people may choose to invest in buy-to-let property but do they understand all the costs and the tax implications? There is also the liquidity issue to consider – what if they needed quick access to their fund?
Personal investment is a complex area to advise on and investors need to make sure the adviser they are speaking to has the relevant experience. Beware of people selling property schemes or funds where the charges can be excessive and you will be locked into the investment with little chance of getting out.
There are a few simple points you should consider before making a decision:
1. Establish a baseline: find out how much pension your fund would provide through an annuity. Check what guarantees are built in. If you die would your pension provide your partner with any financial support? For some cautious clients, annuities may still be the answer.
2. Shop around: if you choose to take an annuity, you don’t need to stay with your pension provider, you are free to shop around. By making use of the “Open Market Option” you could increase your retirement income.
3. Lump sum: taking the tax-free cash sum of 25 per cent can be advantageous but how much will it reduce your pension by? If you take more than 25 per cent you will suffer tax so you need to know what effect this will have on your capital. If you do spend it on, say, a cruise, how much income would the balance provide you with and is that enough to live on when added to any other sources of income?
4. Risk: whether you leave money in the pension fund so you can draw it down when required or take it out and invest it, eg, in property, how much risk can you afford to take? Investments fluctuate in value – how much can you afford to lose? If the answer is nothing, then investing in anything that can fluctuate won’t be suitable.
5. Your experience: making investment decisions can be daunting. Do you understand the charges and the taxation of the proceeds, eg, buying a property involves stamp duty, legal fees, property insurance, the rental income is taxable and any gain on sale is subject to capital gains tax. Make sure the adviser explains all the charges, including his fees, and tax implications.
The golden rule is to do your homework – those who don’t could end up frittering away the income they’ve spent a lifetime saving for. If an investment sounds too good to be true, it usually is.
• Derek Stewart is managing partner of chartered independent financial advisers SAM Wealth