Recent figures from HM Revenue & Customs show more than £6bn has been withdrawn from pensions during the 15 months from the introduction of pension freedoms to July 2016.
The average withdrawals are relatively low and, as we have not seen the Lamborghini effect that was suggested in the run-up to pension freedoms, many commentators are suggesting this is a positive outcome. To me, that seems a remarkably low barrier and we should be looking beyond the headline figures to see if people are getting decent outcomes.
Pension freedoms were always going to drive cash withdrawals from pensions. On the one hand, it can be argued it is simply an inevitable consequence of pension freedoms and people should be able to do what they choose. On the other hand, do we – both the industry and the Government – have a duty to make sure people understand the consequences of their actions?
One obvious concern is people may be withdrawing unsustainable amounts from their pension. Association of British Insurers figures show nearly one in 10 drawdown customers are taking withdrawals of more than 4 per cent a year, with one in 25 taking more than 10 per cent a year. These higher withdrawals are unlikely to be sustainable over the longer term. Some of these people may have other sources of income and capital, so are knowingly running down this pot. But others will be unwittingly doing so.
However, those choosing to blow their funds may well be the least of our worries. The opposite end of the spectrum – the recklessly conservative – are a larger concern. A shocking statistic from Citizens Advice research is 29 per cent of consumers are taking money out of their pension to put into a bank account. I understand people can find pensions confusing and bank accounts are relatively simple and familiar. But this is very unlikely to be a good financial move.
“Do we have a duty to make sure people understand the consequences of their actions?”
First there is an immediate tax hit, so a smaller amount will be available to invest in the bank account than was in the pension. And, given where interest rates are, the capital is very likely to be reducing further, in real terms, with many bank accounts paying a fraction of 1 per cent interest.
Leaving a larger sum in the tax-efficient pension wrapper with a cautious investment strategy is likely to be a much better approach. The pension option also means the money stays in an inheritance tax-friendly vehicle. While that may be less of an issue to those with lower wealth, the research shows the bank account option is taken by an even higher percentage of people with pensions worth £100,000 or more – where IHT may well be more of an issue.
The research also shows one in eight had an unexpected outcome affecting tax or welfare payments as a result of withdrawals from their pension. While some of these would be a result of emergency tax codes being imposed and so will be rectified over time, others are likely to have suffered more fundamental financial consequences.
Overall, the evidence suggests not enough people are getting access to good quality guidance. We all need to show the financial benefit people can get by choosing to take advice – and the Government needs to play a key role. For those who do not want to take advice, we need to push, pull and cajole more into the guidance framework.
There is a huge amount to be done to make pension freedoms the success we all want them to be. Giving people more control and flexibility is great but we need to help them use these powers wisely.
Giving choice means some people will make poor decisions. But that does not mean we should accept the inevitability of that or stop striving to help more people achieve the best outcome for them and their family.
Andrew Tully is pensions technical director at Retirement Advantage