In the 2014 Budget, the Chancellor, George Osborne, announced sweeping changes to the pensions sector by effectively giving individuals the freedom to manage the cash held in their defined contribution pension pots. No longer will individuals have to purchase an annuity to provide a secure income for life, instead these reforms have empowered individuals to make their own decisions on how best to use their pensions savings. These reforms became effective in 2015.
“These freedoms are based on the simple idea that individuals know better how to spend their own money than the Government do" George Osborne
Prior to these reforms the majority of individuals in defined contribution schemes (see my article here) could take 25% of the fund value as a tax-free lump sum and would then need to purchase an annuity with the remaining fund to provide a guaranteed income for life. This method of commuting your accrued pension savings during your working life to a pension in retirement was sound in principle, although it did not provide any real flexibility for consumers. Annuity rates tend to reflect interest and mortality rates, so with interest rates at record lows and the UK population generally living longer, this has generally equated to lower annuity rates (lower income) from the purchased annuity. It also made the prospect of early retirement harder to achieve for most, as the monthly income from an annuity purchased at age 55 would be a lot lower than if the same annuity amount was purchased at age 67.
Since April 2015 the Pension Freedoms can be briefly summarised as:
The earliest age that pensions pots can normally be accessed is 55 for both men and women.
25% of the pension pot can be taken as a tax-free lump sum
The balance remaining no longer needs to be used to purchase an annuity
Individuals can access their remaining fund as they see fit, although any cash withdrawn over the 25% rule above will be classed as taxable income and will therefore be taxed at the individual’s highest rate.
Most consumers and the wider pensions industry have broadly welcomed the reforms although annuity providers have seen a drastic fall in annuity sales since the freedoms were introduced. SIPP / Platform providers have also benefited (more on this specific topic soon) as customers gather up old pensions to bring them under one roof to take control (see my article here on previous pensions).
There are now generally 4 ways to access your pension pot to provide an income in retirement – these are:
Drawdown:– drawing a fixed or flexible income on a regular basis (i.e. monthly / quarterly) from your pension
The Natural Yield:– just taking the income that your investments produce
Annuity:– purchasing an annuity to provide a guaranteed income for life
Combination:-of any of the above methods
These 4 options (all of which have pros and cons) will will be explored in more depth in future articles, so please subscribe here to receive my latest updates.
In my view, the upside of the 'Pension Freedoms" are that they provide consumers with a great deal of choice on how to manage their own pension pot with the potential to provide a rising income throughout retirement. There are however downside risks that consumers need to be aware of such as:
Taking too much income and running out of money in later life
Pension scams – be aware
Bad investment decisions / poor stock market performance / lack of diversification with asset allocation – all of which are very real risks and can seriously affect your pension wealth
The aim of my site is to help people navigate through The Retirement Maze, to guide you through the different options, help you understand pensions in more depth, be in control and provide you with the tools and confidence to either make your own pension choices or to consider (and how to) obtain professional advice. Please subscribe to get my latest updates and start to plan your own pathway to prepare for retirement.
Time invested now will pay dividends later
(and this is certainly true from my own personal experience)
Catch up soon