Savers told to be wary of pension freedom

But experts have warned that the new rules could encourage some people to take too much risk by forsaking annuities and keeping their money at the mercy of markets.

As it stands, investors effectively have to buy an annuity by age 75 because of an 82 per cent tax on death if they remain invested after that. The annuity alternative before 75 - unsecured drawdown - and after 75 (the alternatively secured pension) are being replaced next April with capped and flexible drawdown options, which will be available from the age of 55. However, there are conditions:

n Under capped drawdown the pension fund can remain invested but the money taken out of the fund at any one time can be no more than equivalent to the annual annuity income that could be bought with the fund.

n Those wanting to take out an unlimited amount can opt for flexible drawdown but must have a secure pension income of at least 20,000 a year. The income that counts towards the 20,000 a year includes state pensions - which is typically around 5,000 a year - final salary pensions, scheme pensions and lifetime annuities.

n Unused pensions will be taxable at 55 per cent when they are passed to relatives at death. Drawdown funds are currently taxed at 35 per cent on death before 75 and 70 per cent after, with inheritance tax increasing the post-75 rate to 82 per cent, where applicable.

Most people currently buy an annuity and that won't change. Treasury figures show that while 450,000 people bought an annuity in 2009, some 200,000 left their pension invested with the option of using drawdown to take money from it when necessary and buying an annuity later.

But a combination of the new rules and declining annuity rates mean more people will consider remaining invested.

Graeme Mitchell, managing director at Lowland Financial, said: "There's a hardcore of people who want to remain in control of their pensions and are prepared to take the risk, typically those who are better off. The majority of people still look for the security of an annuity but if you have a range of assets, keeping invested still makes sense."

The reforms will benefit only the wealthiest investors with sufficient alternative funds to justify taking the risk and the extra cost. While an annuity is a one-off cost, the ongoing cost of investing and advice required by drawdown can add up.

And with the minimum income rule for flexible drawdown set at 20,000 a year, investors need a final pension worth at least 550,000, said Adrian Lowcock, of Bestinvest.

"It does mean that people will need to start planning ahead if they are to have a chance of achieving the levels required to avoid annuities," he said.

"Even with the changes most people will still need to buy an annuity. The most obvious beneficiaries will be those with a substantial personal or defined contribution pension - into which most workers now save as final salary schemes decline - who expect to spend more in the early years of their retirement and want to invest more aggressively."

Will Aitken, a senior consultant at Towers Watson, said: "For these individuals, defined contribution pensions now look more attractive - relative to other forms of saving and to defined benefit schemes.

"Some defined benefit members may even find that, once they meet the minimum income requirement, they want to think again about the sort of pension provision they want."

But even then the choice comes down to risk appetite. The key for investors with the option of remaining invested is whether they are risk averse - in which case an annuity is generally more suitable - or comfortable with some investment risk.

In that sense, one difference from next April will be that drawdown becomes a longer-term investment process, Mitchell said. And whether drawdown is worth doing depends largely on whether it is a more effective use of the pension fund than an annuity, making investment advice essential.

"Investment decisions at 70 have been dictated by the five-year time-frame and this will take that approach away," he said. "If you're over 70 and invested but in a risk-averse area it's worth looking at it."

David Gow, of Acumen Financial Planning in Edinburgh, believes while the change will make remaining invested more attractive to many, it was not a decision to be taken lightly.

"Investment returns are likely to fluctuate, and ‘down' periods can be very damaging to the fund while income is also being taken," Gow said. "Say you take an annual income of 6 per cent of the fund. Then you'll need to see your investments within the plan grow at this level, plus extra to cover investment costs and plan charges - say another 1.5 per cent. Otherwise, the value of your pot will be eroded."

Gemma Goodman, of the Alexander Forbes Annuity Bureau, also stressed the risk of keeping a pension invested. While annuity rates are at a historical low, she acknowledged, longer life expectancy means they remain a good option.

"To allow those with larger pension savings unlimited access to their capital [subject to retaining 20,000 income] is likely to see some people sustaining significant losses."