The new pension rules are the most radical in living memory, and the most positive aspect is that they empower people to create the retirement they want.
It will no longer be necessary for anyone to receive a few pounds a week from an annuity because their fund was too small to provide a meaningful income. Instead, they can put the fund to better use, such as clearing the last of the mortgage.
Since George Osborne stated last year that no one would need to buy an annuity anymore, many have taken delight in stating that annuities have not been compulsory since 2006.
This is technically true, but it is not accurate to suggest that the new rule is the same as the old rule. In December 2010, the government itself acknowledged that, thanks to tax charges of up to 82% for alternatively secured pensions, “in practice, annuitisation by age 75 is effectively compulsory for almost all pension savers”.
There is no doubt that the new changes will make pensions more flexible than ever, and the public responded to the announcement. The graph at the bottom of the article shows the difference in how many of our clients wanted advice on their options compared to those who simply wanted annuity quotes, before and after the 2014 Budget.
Of course, the big concerns with the changes are people depleting their funds too quickly, and falling victim to pension liberation scams. Advice is the antidote to these risks. Being informed will help to keep people safer.
The government introduced Pension Wise to explain what the genuine options are, but it isn’t yet known how successful this will be – our own research found that 77% of people had no intention of using it.
As advisers, it is our responsibility to make regulated financial advice readily available in a convenient way for the public. It would be unrealistic to assume that everyone is able to have a face-to-face meeting, and Portal Financial has developed phone and online services to deliver quality advice in ways that suit the client more than travelling to an adviser’s office.
The changes have also made people interested in their pensions again. Being aware that retirement has more to it than exchanging savings for an annuity has prompted people to ask what they can do with their money.
For example, even when people want to take an annuity, pension release can truly benefit a financial situation.
Consider the scenario where a person has a £7,000 loan outstanding and a £28,000 pension (see table, below). Currently, only 25% can be removed. But the pension freedoms will create a new issue for advisers to take: people that want to empty their pension fund.
It is hard to imagine a situation where removing every penny is the best thing to do, and advisers will need to explain the potential tax implications of doing so. The media has been particularly focused on people removing money from their pensions to invest in buy-to-let, although this does not seem a robust idea.
A fund large enough to purchase a house will likely be hit with at least a 40% tax (possibly 45%), so the value of the house would need to increase tremendously just to recoup that loss.
Imagine the hypothetical case of Paul. Now 55, Paul is not working and has a fund of £200,000, which he intends to take all of to invest in a £200,000 buy-to-let.
* After taking 25% tax-free cash, Paul has a taxable fund of £150,000.
* He will pay £53,627 in tax, leaving him with £96,373.
* Stamp duty will be £1,500.
* Paul is left with £94,873.
* He uses £90,000 to get a 55% loan-to-value mortgage, repaid over 10 years, at £1,100 a month.
* The remaining £4,873 is to cover any fees and property refurbishments.
* Paul sets the rent at £1,500 a month and pays 15% (£225) to a letting agency.
* Paul earns £275 a month, or £3,300 a year, before maintenance and void periods.
His income is not enough to replenish the tax he paid, so the property needs to increase in value substantially.
However, he would then be liable for capital gains tax when he sells. On the other hand, he is vulnerable to drops in house values, especially as his investment is in a single property.
Clearly, buy-to-let is not as appealing as we could be led to believe. But we should expect that some people will want to do it regardless. For some, it may turn out to be rewarding. There is no one-size-fits-all answer in finance, and removing the necessity to buy an annuity means people will be able to select the most appropriate choice for them.
The pension freedoms have their critics, but the traditional rules were not perfect. According to the Financial Conduct Authority, 60% of people simply stayed with their existing pension provider for an annuity, while 80% of them could have been better off by shopping around.
The promise of the new pension rules is freedom, and if people want to go against advice, they are able to do so. We can do little more than explain the options and the associated risks. Then, it is up to them.
We have the freedom to spend our salaries as we wish, and it stands to reason that the same is true of our retirement income too.