People who have worked hard and saved hard all their lives, and done the right thing, should be trusted with their own finances. Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want. No caps. No drawdown limits. Let me be clear: no-one will have to buy an annuity.”
Those were the words uttered by then-Chancellor George Osborne in March 2014 announcing the introduction of “pension freedom”.And three years later, not only have Britain’s army of savers embraced that freedom, they’re cock-a-hoop, head-over-heels in love with it.
Last week, the Financial Conduct Authority (FCA) published the findings of a huge investigation into the post-freedom retirement market. It revealed that around one million pension pots have been accessed in the way Mr Osborne described.
More than half of these pensions have been withdrawn in full – people are cashing in on their retirement savings with aplomb, largely eschewing the security of a guaranteed income from an annuity.
And people cannot wait to get their hands on their money – almost three-quarters have been accessed by people aged under 65.
But does the FCA love the pension freedoms as much as savers? The jury’s decidedly out.
It did observe that people are behaving responsibly – it found no evidence of savings being squandered, with 94 per cent of those who’d taken all of their money out doing so with another source of income, such as the state pension or a final salary pension, to rely on in retirement.
But it identified some worrying patterns emerging as the pension freedoms have bedded in. Trust, it found, in the retirement savings industry is at such a low that many people are taking money out of their pension simply because they don’t want it in a pension. Where is this cash going? A third into savings and current accounts, often paying inferior savings rates. There are literally no savings accounts or Isas that come without any restrictions that currently beat inflation, while current accounts paying interest cap the amount you can earn and put all sorts of funding requirements to qualify.
Either you’ve become the smartest saver to juggle your money around the cash market to generate a decent liveable income with your pension savings – or you’re losing money in real terms.
And in the fervour to get their money further from their pension, the FCA found retirees are risking big tax bills and losing out on valuable benefits, such as guaranteed annuity rates, which often pay more than those offered in the open market.
On the point of taxation, there’s a double whammy waiting. While the retirement income market might have been revolutionised by the pension freedoms, the government’s tax systems haven’t become as flexible.
When savers take a lump sum from their pension for the first time, it is taxed as though that sum is what they’ll earn every month. This means someone taking £20,000 from their pension could be taxed as though they’re a 45 per cent taxpayer. They’ll get a rebate if they submit the right application, or at the end of the tax year, but if you don’t know that you’ve been overtaxed, the chances are you won’t think to ask for your money back straight away. And while it was government policy THAT designed the pension freedoms, subsequent tweaks could actually harm people’s ability to build up the biggest pot possible. As I wrote in my last column, the amount you can put into your pension after you’ve accessed your money flexibly drops dramatically – from £40,000 a year to just £4,000.
With so many savers now accessing their money before retirement age, more and more will be dragged into this reduced annual allowance net, and find their ability to save for the future inhibited. The FCA is also concerned that so many people are pouring into drawdown plans, which see their money left invested as they take a flexible income from their savings, without advice or shopping around, simply taking the deal that’s offered by their pension provider. Does that sound familiar?
The whole reason the freedoms were introduced was because the annuity market was failing consumers – with poor rates and bad practices leading people to swap their life savings without being offered the best deal in the market.
Two years into Mr Osborne’s grand experiment, the FCA’s report suggests that the same problems could be emerging. It’s right that the regulator takes action now to ensure that the legions of excited retirees rushing to liberate their pension savings don’t steam into a market that could leave them worse off in later life.
Gareth Shaw is head of Which? Money Online