What's the price of pension freedoms?

Well, about £5.1 billion by April 2019.

That’s HM Treasury’s forecast for additional tax revenue from the pension freedoms that allow retirees to access their pension savings from 55.[1]

The Financial Conduct Authority (FCA), in the final report of its Retirement Outcomes Review, highlighted how since the pension freedoms, there has been a substantial shift away from annuities, more consumers are taking drawdown without advice and twice as many pots are being used to drawdown than to buy an annuity.

The report also showed that a third (32%) of pots were accessed without advice, compared to just 5% before the freedoms. And there does seem to be confusion amongst consumers unsure as to where their pots are invested (28%) or those who thought they knew being mistaken.

In our recent survey, more than a quarter of the 2,000 over-55s who took part in the survey, didn’t know they had to pay tax on at least some of their pension income.

We found that many consumers don’t realise contributions to private pensions are made with full tax relief, and are surprised that tax might have to be paid if they take out all their pension savings as cash. Women are particularly unprepared for this, as are those with smaller pension pots.

Of those surveyed, nearly 43% thought taking money out of their pension savings would be tax-free. Within those 43%, nearly 20% thought that all of it would be tax-free and only 45% thought it would be in the 21-25% range.

Financial security is paramount

From the introduction of pension freedoms in April 2015 to September 2017, over 1.5 million defined contribution (DC) pension pots have been accessed.[2] Over half of all pots accessed were fully withdrawn, and half of these were not spent, but transferred to other savings or investments.[3]

In our survey, we found that 30% of people aged over 55 are not prepared to take big risks with their retirement savings, while almost half said they would want to avoid risking any of their pension income. A significant majority of over-55s were also not prepared to risk their pension, even if the potential return doubled.

Findings from the FCA’s Understanding the financial lives of UK adults report show that consumers understand that this income needs to last a lifetime, but don’t understand the options open to them. They end up withdrawing their money from their pension pots, despite the tax implications, and putting it in cash-based investments or even their bank account, where it accumulates little or no real interest.

With Financial security and a guaranteed income picked as the two most important factors in retirement for our survey respondents, it’s understandable that they think cash is a safe haven for their money. But the FCA estimates that someone who wants to draw down their pot over 20 years, could increase their expected annual income by 37%[4] through investing in a mix of assets rather than just cash.

And yet, we found that consumers often spend more time choosing a new car or bathroom suite than thinking about how to access their pension savings.

“I’m not sure what I’ve got”

Our survey suggests, and the FCA’s Data Bulletin[5] backs this up, that there is considerable confusion among consumers about their options at retirement.

In the FCA’s Financial Lives Survey[6], it found that 18% of people who have accessed a DC pension in the last two years, reported that they get an income or have taken a cash lump sum, but are not sure how this works.

There is also confusion about the features of each product. For example the FCA’s Data Bulletin shows that  only six in ten knew that a lifetime annuity would give them a guaranteed income for the rest of their life; 11% thought that there was a risk that the value of their fund could go up or down. In addition, less than half of the consumers who made a retirement income decision in the last two years, thought about their health or life expectancy.[7]

Our own research showed that many consumers profess to having insufficient knowledge to be able to evaluate the risk of different retirement income products, but they did recognise that annuities were fairly low risk.

As Emma Byron, Managing Director of Retail Retirement Income, explains:

The biggest problem is that awareness about pensions remains very low. It can be all too easy to leave retirement planning to the last minute, or make quick decisions about how we access our pension income, but this can end up costing us more in the long run and potentially expose us to more risk than we want. This confusion needs to be removed if we are to increase engagement in this area and ensure consumers are getting the most value out of their pension. We need to talk about retirees’ plans, and consider how various retirement income products can work together to help them to achieve their goals.

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[1] Oliver Wade. 2018. HM Treasury to benefit from £5.1bn bonus due to pension freedoms. [ONLINE] Available at: http://www.pensionsage.com/pa/HM-Treasury-to-benefit-from-5-1bn-bonus-due-to-pension-freedoms.php. [Accessed 3 October 2018].

[2] Financial Conduct Authority, June 2018. Retirement Outcomes Review: Final Report. MS16/1.3, Page 4.

[3] Financial Conduct Authority, June 2018. Retirement Outcomes Review: Final Report. MS16/1.3, Page 4.

[4] Financial Conduct Authority, June 2018. Retirement Outcomes Review: Final Report. MS16/1.3, Page 5.

[5] Financial Conduct Authority, March 2018. Data Bulletin. Issue 12, Page 3.

[6] Financial Conduct Authority, October 2017. Understanding the financial lives of UK adults: Findings from the FCA’s Financial Lives Survey 2017.

[7] Financial Conduct Authority, March 2018. Data Bulletin. Issue 12, Page 3.