The pension picture
The new pension freedoms have raised the profile of retirement planning and now is the time to review your affairs.
It is now six months since the biggest shake-up in UK pensions in a generation greatly increased flexibility over when, and how, benefits can be taken. The impact of these changes has not been properly assessed yet and there could be further changes as the government consults on even more radical alterations.
The most visible impact of pension freedoms has been on annuity sales. While it has long been possible to draw a flexible income from a pension fund, rather than buying an annuity, rules on the amount that could be withdrawn, coupled with the costs of arranging drawdown, meant it was mainly only appropriate for larger funds. Now, however, savers are free to withdraw as much as they like from their fund, either all at once or in a number of instalments – although withdrawals over the tax-free limit of a quarter of the fund will be subject to tax at the individual’s highest marginal rate.
Early indications are that those with smaller pots are choosing to do just that. The Association of British Insurers (ABI) said that, in the first 100 days after pension freedoms, £1 billion in cash was taken from pension pots through 65,000 withdrawals – an average of more than £15,000 per withdrawal. Income drawdown accounted for a further £800 million of withdrawals across 170,000 policies, while 11,300 annuities with a total value of £630 million were purchased. That compares with the peak for annuity purchases of £1.2 billion per month in 2012, when income drawdown accounted for just £100 million per month1.
Dr Yvonne Braun, the ABI’s Director for Long Term Savings Policy, said: ‘The data shows people with smaller pots tend to be cashing them out, while those with larger pots tend to be buying a regular income product, such as an annuity. It also highlights an increase in the number of people putting money into income drawdown products that can take advantage of the new freedoms.
‘We are just a few months into the biggest overhaul in pensions for a generation, which was introduced in only one year, so some issues still need to be worked through.’
Of course, the main aim of retirement planning is to provide an income for the entire period of your retirement – and that could be a long time. Government statistics published in its green paper Strengthening the incentive to save: a consultation on pensions tax relief [July 2015], points out that a man who reached 65 in 2012 can expect to live for a further 21 years, and a woman for 24, and longevity is expected to increase further. While the increased flexibility in how pension income can be taken is welcome, the most important thing is to build a retirement fund that is large enough to last the rest of your life.
The tax incentives to do that have already been reduced: just a decade ago, there were few limits on the amount that could be saved in a pension pot.
“Investors should be maximising their contributions while they can”
In 2006, the then Labour government introduced a lifetime allowance of £1.5 million and, while that was gradually increased to £1.8 million by 2010, it has been falling ever since – next April it will be £1 million and will stay there until 2018, when it will rise in line with the Consumer Prices Index. The government will allow some protection for those with pots above the £1 million level, although the details have yet to be announced. From next April there will be further restrictions for those with an income of more than £150,000 per annum.
One of the proposals in the government’s green paper is to end tax relief on contributions completely, shifting to a regime similar to that for ISAs, under which there is no tax relief on contributions but withdrawals are tax-free. While Chancellor George Osborne says he has an open mind on reform, he adds: ‘With increased longevity and the changing nature of pension provision, the government needs to make sure that the system incentivises more people to take responsibility for their pension saving so that they are able to meet their aspirations in retirement. If people are to take responsibility for their retirement, it is important that the support on offer from the government is simple and transparent, and that complexity does not undermine the incentive for individuals to save.’
The financial incentives for reform are clear: tax relief restrictions introduced since 2010 have saved the government £6 billion a year but the green paper says a simple estimate of the cost of tax relief, less the tax received on pension income, is £21.2 billion a year.
Set against that, however, is the need to encourage people to save for retirement, although pension freedoms, coupled with the automatic enrolment into workplace pensions, is raising the profile of the issue.
Given the uncertainty around tax incentives, investors should be concentrating on maximising their pension contributions while they can. As Ian Price, Divisional Director for Pensions at St. James’s Place, says: ‘My time in the industry has taught me that no one knows what the regime will be in a few years, so you have to invest according to the rules that exist today. Everyone should be reviewing their affairs. High earners, in particular, should consider making contributions now while tax relief is still available.’
A broader portfolio of investments, including ISAs, has become more popular for providing retirement income, both because of changes to working patterns and the erosion of tax reliefs, with retirement getting later or phased over a number of years. Pensions will, however, remain a core component of retirement planning.
1 Association of British Insurers, July 2015
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The levels and bases of taxation and reliefs from taxation can change at any time. The value of any tax relief depends on individual circumstances.