The new pension freedoms set to grace the market have been welcomed by many, but some industry experts aren't so sure. Just Retirement is even warning that the reforms could have serious consequences for a lot of retirees, after figures reveal a sharp rise in the number of pensioners choosing to take out income drawdown plans rather than opt for the guaranteed income of an annuity.
In a nutshell, the changes mean that there'll no longer be the obligation to annuitise. Not only can people access their entire pension pot should they wish (subject to a nominal tax charge rather than the prohibitive 55% tax rate of current rules), but the rules surrounding drawdown pensions have been relaxed, too.
The amount of guaranteed income you'll need to access flexible drawdown – a pension that allows you to draw an income from your fund with the remainder staying invested – has been reduced from £20,000 to £12,000 per year. Capped drawdown limits have also been changed, with these products now allowing you to withdraw a maximum of 150% of an equivalent annuity from your pension pot each year (up from the previous limit of 120%).
In essence, this means people have a lot more flexibility when it comes to deciding what to do with their pension, with drawdown (either the flexible version, where there's no limit to the amount you can withdraw per year, or the capped version) becoming a much more viable possibility.
While the changes may sound like a good thing, the key concern, when it comes to drawdown at least, is that the freedoms will allow some people to make over-ambitious investment choices – in other words, they could be risking money they simply can't afford to lose. While keeping their pension funds invested could sound appealing to many retirees, it's an investment like anything else, and this means that the value of their pot could fall as well as rise in line with stock market fluctuations.
When retirees rely on their pension to provide an income throughout retirement, that's a big risk to take on board. What if their investments didn't perform well and their pot dwindled? In the best-case scenario they'd withdraw their funds or turn it into an annuity before things got too bad, but in the worst case their pot could become seriously depleted.
"It seems that people who once would have been discouraged from taking investment risk with pension money are now opting for plans that are likely to be more risky and complex," said Stephen Lowe of Just Retirement. "There's no problem with people taking more investment risk if they can afford to ride out the ups and downs. The problem comes when people are relying on those investments performing in order to pay day-to-day living costs, because history tells us that asset prices fall as well as rise."
The concerns were raised after figures from the Association of British Insurers (ABI) revealed that sales of annuities – products that provide a guaranteed income throughout retirement – have fallen by a third since the Budget announcement earlier this year, while sales of drawdown plans have soared.
The figures show that just 46,368 annuities were sold in the second quarter of the year (with a total value of £1,792m), compared with annuity sales of 74,270 (worth £2,478m) in the first three months of 2014. Conversely, there was a 35% increase in the number of drawdown contracts sold over the same period – there were 9,498 sales worth a total of £669m in the second quarter, compared with 6,132 sales worth £487m in the first three months– indicating that people are increasingly taking advantage of these more flexible drawdown arrangements.
This, said Stephen Lowe, isn't necessarily ideal. He pointed out that however prudent, experienced or even lucky investors are, they have no way of knowing what lies ahead or how long their pension fund will need to pay out, and that's why securing a core of guaranteed lifetime income (perhaps from a combination of the State Pension, annuities or final salary schemes) is so important.
"Investment and longevity risks are ones that individuals find it very hard to cope with and exactly the reason annuities were invented in the first place," he added. "With an annuity you can spend the income without worrying if it will dry up tomorrow. Under the new rules, our worry is too many people will start risking money they can't afford to lose."
Ultimately, this means that opting for the security of an annuity should still be considered by many retirees. There's nothing to stop you from using a combination of methods, after all – you could use some of your pot to purchase an annuity while keeping the rest invested to draw down at a later date – and as long as you consider all the options, you won't need to suffer the downside of pension freedoms.
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