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April fools?

14 January 2015

Research suggests that new pension freedoms due to come into force this spring will not encourage profligacy.

The end of the tax year is typically a busy time for people investing for their retirement. Many will be making the most of their ISA allowance, or ensuring they make pension contributions while higher rates of tax relief remain. But this spring, people who are retiring with a defined contribution pension will have even more to mull over.

From 6 April, people over the age of 55 will be free to take unlimited lump sums from their pension without having to buy an annuity or enter drawdown. And those in drawdown will not face restrictions on how much they can extract in a single year. Although the Chancellor’s Taxation of Pensions Act will bring many new freedoms for pension savers, there is widespread concern from critics that liberalisation will encourage recklessness.

A report recently published by Fidelity Worldwide Investment sheds light on how 500 people retiring between April 2015 and March 2016 intend to use their pension fund. The results of the study are interesting. Rather than validate fears that the new pension freedoms will trigger a spending spree, the report’s findings support the view that most people understand that the purpose of a pension is to provide an income for life.

The report reveals that only 11% plan to take more than their tax-free entitlement as a lump sum, and only 6% plan to cash in the entire fund. Although the study reveals respondents’ intentions rather than their actions, these findings do perhaps indicate that greater freedoms will not necessarily equate to widespread financial mismanagement.

While there’s evidence to suggest that the tax-free lump sum will be an opportunity for some to indulge – 42% say they will treat themselves – for others it will be dedicated to prudence. Around a third of respondents said they were planning to invest at least some of it into shares or bonds, and a fifth to pay off personal debt.

Furthermore, the research puts into doubt the demise of annuities. These will play an important, albeit reduced, role according to Fidelity, with 16% of respondents saying they will buy an annuity and 18% saying they will combine annuity and drawdown to provide a blend of income flexibility and security. Almost a quarter said they will transfer their pension pot to drawdown, and 16% will leave the fund untouched and invested for growth. The figures add weight to the argument that, rather than cashing in the entire pot, most people will continue to exchange their pension for a guaranteed lifetime income, or leave it invested with the option to take withdrawals.

Steve Webb, the Liberal Democrat pensions minister, who helped develop the new rules, concedes that there is a danger that greater freedoms could mean people end up making poor decisions, or find themselves unwittingly pushed into the higher rate tax band. These and other potential pitfalls highlight the need for advice as a vital component of a pension plan, comments Ian Price, Divisional Director at St. James’s Place.

However, the report reveals that only 35% of those questioned will seek financial advice from an expert; 17% have a clear plan in place; and just 15% are reviewing their existing retirement plan. Although almost half say they have a good understanding of the new rules, the remainder could end up making decisions based on limited knowledge.

“It’s clear that this generation of retirees is not reckless,” adds Price. “Most have saved all their life and understand that they need to make their pension last for as long as they do. But making sensible choices means taking professional advice. No one should do anything without taking advice first.”

The end of the tax year is a time when people should ensure that tax-saving opportunities are maximised and review whether their retirement objectives are on track. But with tax year-end coinciding with new pension freedoms, people in or at retirement will have a raft of extra options to consider. The need for a clear plan is more pressing than ever; and the best way to take full advantage of a plan is to start making one now with a qualified financial adviser.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.


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