Many savers are draining pension pots so rapidly they risk running out of money in retirement, an industry report warns.
Two in five over-55 are withdrawing cash at a rate of 8 per cent or more – far outstripping the 3.5 per cent recommended by experts as safe.
Meanwhile, nearly half are tapping pensions without using the Government’s free guidance service PensionWise or paying for financial advice, according to data cited by the Association of British Insurers.
Pension freedom: Over-55s have greater power over how they spend, save or invest their retirement pots
‘Cash today, poverty tomorrow must be avoided, as large withdrawals from pension pots could mean later life hardship for many,’ says the organisation, which is backed by the UK’s big pension firms and insurers.
Pension freedoms launched nearly five years ago gave over-55s unfettered access to their pots.
But while the reforms are popular with savers, who enjoy full control over their savings, watchdogs and industry experts fear some are making potentially harmful decisions and could run out of money in retirement.
Plans are under way for four ready-made or ‘default’ investment deals for people who want to dip into their pots, and savers now receive new simplified ‘wake up packs’ from pension providers at age 50 instead of just before retirement.
What is pension freedom?
Pension freedom reforms have given over-55s greater power over how they spend, save or invest their retirement pots.
Key changes from April 2015 included removing the need to buy an annuity to provide income until you die, giving access to invest-and-drawdown schemes previously restricted to wealthier savers, and the axing of a 55 per cent ‘death tax’ on pension pots left invested.
The changes apply to people with ‘defined contribution’ or ‘money purchase’ pension schemes, which take contributions from both employer and employee and invest them to provide a pot of money at retirement.
They don’t apply to those with more generous gold-plated final salary or ‘defined benefit’ pensions which provide a guaranteed income after retirement.
However, those still saving into such schemes can transfer to DC schemes, provided they get financial advice if their pot is worth £30,000-plus.
But the ABI is calling for further action, including new ‘later life reviews’, compulsory risk warnings for people wanting to abandon guaranteed final salary pensions, and a ban on unregulated investments to combat scams.
It notes that many current retirees have final salary pensions, which provide a guaranteed income until you die. This gives people more leeway to spend or invest other pots.
But such generous schemes are in decline, so younger savers will have to rely on pensions they need to invest wisely to provide an income.
‘The jury is still out on the success of the pension freedoms,’ says Huw Evans director general of the ABI.
‘We will only be able to judge their true impact decades from now, once it is clear whether those who have exercised their choices have the retirement that they were hoping for.’
How fast should you tap your pension pot?
‘There have been concerns about people exhausting pots prematurely since the introduction of the freedoms,’ says the ABI.
Although 4 per cent a year is frequently offered as ‘a rule of thumb’ to savers, the organisation suggests in its ‘Future-proofing the freedoms’ report that this isn’t cautious enough.
It cites Pensions Policy Institute research showing a 3.5 per cent withdrawal rate ‘ensures a 95 per cent chance of not exhausting savings by time of death’, while a 7 per cent withdrawal rate ‘gives around a 50 per cent chance of exhausting savings by average life expectancy’.
The ABI adds that the Institute and Faculty of Actuaries has suggested 3.5 per cent is a safe rate too – but evidence points to many people taking more than twice that much.
‘In 2018/19 the FCA found that withdrawal rates of 8 per cent and over were the most common rate across all pot sizes except for the largest pots,’ it says.
‘Forty per cent of withdrawals were at an annual rate of 8 per cent and over, and this had increased compared to 2017/18.’
However, former Pensions Minister Ros Altmann says that although customers are cashing in their pensions in far larger numbers than ever before, that does not prove their decisions are incorrect.
‘To know whether those people transferring their pensions in full are risking later life poverty, requires knowing the size of the fund being cashed and what other resources and pensions that person has,’ she says.
‘The real benefit of the pension freedoms is that people can keep money in their pensions into their 80s and 90s, without fear of punitive taxation and without having to buy a poor value annuity with no inflation protection for their income, so their pension loses value in real terms over the years.’
Lady Altmann says that although the free PensionWise service is excellent, take-up has been woefully low.
She adds that lines of defence for customers who call their pension provider should include directing them to PensionWise and asking a few basic questions to detect scams.
‘In particular, asking whether they received a cold call which initiated the transfer request, whether they know the person who recommended this course of action, whether they know anything about the investment they want to move to, or whether they have been to PensionWise or used an independent financial adviser, could help protect customers better.’
What other pitfalls are there when using pension freedoms?
There is evidence that people are falling into a common tax trap, especially when they don’t get financial advice or use PensionWise.
Savers who access any amount over and above their 25 per cent tax free lump sum are only able to put away £4,000 a year and still automatically qualify for tax relief from then onward.
If you breach the £4,000 limit, known in official jargon as the Money Purchase Annual Allowance or MPAA, you could face a big tax bill down the line.
The ABI is urging the Government to take a closer look at the MPAA and the negative effect it can have on savers.
Meanwhile, people investing pensions could be in danger of running out of cash or racking up losses in a market crash because they don’t realise they can adjust or stop withdrawals, separate research reveals.
Retirees often need to keep taking an income from investments to cover living expenses in old age, but pension experts warn they should tap cash savings and other assets if possible during market upsets.
This is to avoid something known as ‘pound cost ravaging’ which can take a severe toll on pension investments, especially in the early years of retirement.
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