The radical overhaul announced by the Chancellor, which gives people more freedom in how they use their pension pot, will result in a sharp rise in the number of people remaining invested in retirement.
Under the current rules the vast majority of people in defined contribution (DC) schemes expect to use their pension pot to buy an annuity, giving them a guaranteed regular income in retirement.
But a raft of new rules set out in last Wednesday’s Budget have for many pension savers moved the proverbial goalposts. Among the changes are a relaxation of the rules on income drawdown, which allows retirees to keep their pension pots invested and take income from it in tranches.
From 27 March that option will be opened up to people with a guaranteed annual income of £12,000, down from the existing £20,000. The maximum amount of the income that can be taken in capped drawdown will at the same time rise from 120 to 150 per cent of the equivalent annuity. The amount of savings that can be taken as a lump sum at retirement will be increased from £18,000 to £30,000.
Further changes taking effect next April will allow people in DC schemes to take their whole pot as a lump sum, with 25 per cent tax-free (as now) and the remainder charged tax at their marginal rate. The charge for taking more than 25 per cent is currently 55 per cent.
While annuities will remain the best option for a large proportion of retirees, the number using drawdown or taking their cash in one go is set to soar.
That means many people with retirement investments built around an intention to buy an annuity at retirement may instead continue to invest in retirement. But that presents new risks, said Patrick Connolly, certified financial planner at Chase de Vere.
“It is difficult to argue with a new regime which will provide more flexibility and greater choice for those looking to take pension benefits,” he said. “However, with more flexibility comes more scope for people to get it wrong, either deliberately or by accident.”
Anyone planning to take their pension benefits over the next couple of years urgently needs to review their existing retirement planning strategy, he added.
“Many more people are likely to remain invested into their retirement, either in pensions or moving their money into Isas, and these people will need to readdress their investment strategy,” said Connolly. “They will be able to take more risk because they’ll be investing for longer.”
Eschewing the certainty of annuities and remaining invested places the responsibility on investors to use their savings effectively. One of the biggest challenges is making sure the pot isn’t drained prematurely, said Bill Saunders, head of financial planning at Acumen Financial Planning in Edinburgh.
“It is not unusual for retirement to last 25 years or more now, so calculating how much capital you need is not straightforward, and easy to underestimate,” he explained.
“Even if inflation is only running at 3 per cent a year the cost of living will more than double between the ages of 60 and 85.”
Millions of people have their pension contributions invested by default in “lifestyle” strategies that are designed for annuity purchase at retirement. These typically move the pension out of equities and into fixed income and cash in order to reduce risk as retirement nears.
Some £165 billion is invested in lifestyle strategies, estimated Laith Khalaf at Hargreaves Lansdown, who claimed that most such funds are now “obsolete”.
“Absolutely everybody who is invested in a default fund in their company pension scheme should dust it off and take a close look at it; the fund may no longer be fit for purpose,” said Khalaf.
Sanders agreed, suggesting anyone now more likely to remain invested in retirement will need to review their asset allocation.
“This could mean moving out of lifestyle funds, for example. In order to generate a worthwhile income in retirement and preserve at least some capital, it will be necessary to continue investing in a broad spread of assets prior to and throughout retirement.”