Pension savers on benefits are in danger of slipping through the cracks of the new freedoms by taking cash and losing their entitlements to state help.
The reforms unveiled by Chancellor George Osborne in the Budget will come into force from 6 April, giving savers far greater control of their pensions than ever before.
But savers receiving means-tested benefits – such as housing benefit, council tax deductions, income support and income-based jobseeker’s allowance – could find payments cut or stopped altogether if they take too much cash at once.
There are also question marks over how courts will view pensions assets being chased by firms for loan repayments.
Former Which? financial services policy team leader Dominic Lindley warns the changes mean savers rushing to access their pension pots could inadvertently deprive themselves of income. Not only do they risk moving into a higher tax band than normal and paying unnecessary income tax, but lump sum withdrawals could push their assets above the threshold of some means-tested benefits.
As of now, untouched pensions will not be taken into account by the Department for Work and Pensions when assessing benefit claims but as soon as savers access their pension, those ‘crystallised’ assets will be in scope.
Lindley says: “If they turn their pension into cash, it will start to affect people’s entitlements to those state benefits.
“The amount held in pension funds is excluded from those calculations but if you take money out it will count against those entitlements. For instance, if someone withdrew all their fund as cash at age 58, they could completely lose their entitlement to state benefits.”
Under current rules, anyone below pension credit age with capital up to £16,000 can apply for housing benefit to help pay part or all of their rent. However, once an individual’s wealth goes above £6,000 they will start to see a reduction in benefit, and once over £16,000 it will stop completely.
Reductions in council tax have similar limits but these can vary between different local authorities.
Aside from capital, benefits are also assessed against individuals’ income and rent and are dependent on where they live.
Lindley says: “People are going to have to be careful because they could quite easily go above the capital limit after taking withdrawals from their pensions.”
He adds that the Government-backed guidance service, Pension Wise, needs to help consumers in this area, but fears the sessions, likely to be 45 minutes long, already have a lot to cover in a short space of time.
He says providers delivering their own unofficial guidance could leave customers unprepared.
“You’ve got to ask how many pension companies will ask customers if they are entitled to housing benefit and council tax reduction? They may mention the tax implications, but they have never had to think about those kinds of things before, hopefully some of the more responsible companies will.”
‘Deliberate deprivation of assets’
When responding to concerns the pension freedoms could lead to savers splurging their savings before falling back on the state, pensions minister Steve Webb has a few stock rebuttals.
He says it would be out of character for people who have saved for a pension to then blow it all at once, that the Pension Wise service will help people realise the consequences of spending their savings too quickly, and that existing rules will block people intentionally spending their pension to take advantage of means-tested benefits.
The ‘deliberate deprivation of assets’ rule is meant to stop people abusing the benefits system and, if caught, culprits will be treated as still possessing the spent capital.
But Aviva head of pensions policy John Lawson says it will be impossible for the DWP to keep a track of how savings have been spent and for what reason.
He says: “How long do providers keep records of customer actions for? We write those records off after about 6 years or so, in which case that data might not be there at the point you want to go back and investigate.
“It’s all a bit woolly at the moment, it definitely needs to be addressed. People will behave more responsibly if they understand what consequences their actions have.”
Age UK head of income and poverty policy Sally West agrees that assessing a saver’s intention is difficult.
She says: “There may be good reasons why you’re spending your money but it’s very hard to show one way or the other.
“The longer the gap between taking the money and actually using the benefits, the more difficult it is to determine the reasons why someone did something. It’s about deliberate deprivation, but people could have no idea what the impact will be in a few years’ time. You’d have a strong case to say you didn’t expect to claim benefits when you withdrew the money years ago.”
Currently, once someone reaches pension credit age, which is pegged to the state pension age, DC pots are given a notional income to calculate means-tested benefits. In the Autumn Statement, the Chancellor announced the assumption would be based on the higher of 100 per cent of the GAD rate or the actual income taken.
But West says there is now “added complexity” because “it’s not a one off decision.”
She says: “They may assess you but then because of the flexibility your pension fund may change as you draw some of it out. Will you be expected to report each time you access savings flexibly?
“It’s the same as all aspects of the pension reforms. Although people welcome the reforms, it’s not a one-off decision. You need to be continually thinking what do I do next and how might that impact on my benefits?”
A DWP spokesman says withdrawn funds will be considered as capital or drawdown on a case-by-case basis.
He adds: “People below the qualifying age for pension credit and claiming means-tested benefits will continue to see their pension pots disregarded if they do not take advantage of freedoms.
“The new Pension Wise service will be delivered to rigorous FCA standards, and we are developing the guidance so it encourages people to consider the impact of benefits so they can make their own, informed choices.”
It is also unclear how the pension reforms will interact with savers’ debt.
Key Retirement group director Dean Mirfin says: “Being able to take funds as cash completely changes the whole makeup.
“Do you force someone to cash in their pension and leave them with no retirement savings? Some would say why should the credit card company that you owe money to not be able to make you use your pension?”
Lindley thinks lenders may begin to test the water and see if they can chase borrowers’ pension to repay debts via an income payment order.
However, two recent conflicting court cases have muddied the waters.
An Insolvency Service spokeswoman says: “The Insolvency Act is clear that income from a pension in payment can be taken into account when assessing income for the purpose of an income payments order.
“The courts have considered whether an undrawn pension might be brought into the calculation of available income but the most recent judgment indicates that this is not the case.
“Approved pensions remain excluded from a bankruptcy estate. If excessive payments have been made into a pension pot whilst the person was insolvent, these can be reclaimed on behalf of the creditors.
“In cases where there is a very large pension pot which could be drawn down, this should be taken into account by the Court in deciding whether the person is insolvent and thus whether a bankruptcy order should be made.”
Scott Gallacher, director, Rowley Turton
Many vulnerable people will inadvertently lose out as for the people most at risk – those on benefits with modest pension pots – the new lump sum option will be the most attractive but also the most dangerous option. The average person has a pension pot of £30,000, and given the choice of £7,500 tax free cash and an annuity of around £100 per month, or a one off total lump sum of around £25,000 net of basic rate tax, many will no doubt choose the lump sum.
Unfortunately they could then lose means tested benefits in two ways. Firstly their taxable income would include £22,500 one off ‘income’ payments, and secondly they would also exceed the £10,000 capital limit for many benefits.
Tristan Brodbeck, director, Tristan Brodbeck Financial Planning
All citizens are vulnerable to the whims of the State, the less well-off especially so. Those in receipt of benefits or being chased by creditors are most in need of quality advice and yet by definition are less likely to be able to afford it or, sadly,understand it.