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Pension Freedoms Long Overdue – But New Risks Posed

The March 2014 Budget announced the biggest overhaul to pensions in the history of reforms. The announcements have been very much aimed at giving people more choice and flexibility, allowing retirees more control of their pension pots, as opposed to being forced to buy an annuity (pension income for life) as was the case for the majority of individuals at retirement.

As is often the case with reforms, with greater flexibility and choice also comes a new set of risks that need to be considered carefully before any decision is made. Some commentators within the financial services industry are also predicting that the new changes may give rise to another financial mis-selling scandal with individuals not receiving adequate or appropriate advice.

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An Open Field

The list of pension reforms is quite large. But the biggest and most relevant is that you no longer are forced to buy an annuity at retirement. Prior to the announcements on the new options, there were effectively only 2 main options for securing an income at retirement:

1. Exchange your pension pot for a guaranteed income for life (pension annuity)

2. Place your pension funds into an income drawdown plan, however this was only mainly suitable for those with large pension pots (in excess of £100,000) and those with other main sources of retirement income.

In April 2015, the rules will also change the way in which you can access the 25% tax free lump sum available. Access to the 25% tax free lump sum will work in 2 ways:

  • Take a quarter of your pot all in one go, and entirely tax free, with the remaining 75% remaining within your pension plan
  • Making withdrawals when needed, with a quarter of each withdrawal treated as tax free

There is a fear that the new flexibility of being able to withdraw your pension as and when desired may result in many indiviudals taking the view that their pension plans are now effectively the same as their current or savings bank account.

Nicola Hartley, Independent Financial Adviser at SM Financial Services, commented, “Whilst the new flexibility of being able to withdraw from your pension as and when required makes it easy to compare the plan to a bank account, it could be that the remaining pension funds are invested within the financial markets. This means that the value of your pension will go up or down in value on a daily basis and any value cannot be guaranteed.

It is important that individuals are aware of the underlying funds and investments held and are:

(a) comfortable with the level of risk taken with the invested funds, and

(b) aware of any limitations or restrictions that the funds may bring.

This may be difficult to do if individuals intend to self manage their pensions and independent financial advice is not received.”

New Risks

Tom McPhail, Head of Pensions Research at broker Hargreaves Lansdown further reiterated this point stating: “The Chancellor appears to be creating the perfect environment for a mis-selling scandal”, expressing concern at those who will make retirement decisions without seeking independent financial advice. Tom believed that many retirees may be encouraged into risky investments or could be left with inadequate returns when they manage their investments and withdrawals themselves.

Nicola Hartley continues, “This new flexibility has been long overdue within the pension industry, however, individuals should be aware that with this also comes the need to ensure effective financial planning is received.

This can assist you in making the best use of income tax bands whilst also ensuring that your pension plan is held in line with your objectives, timeframe and attitude to risk. Receiving independent financial advice allows strategic planning to be put in place to get the most from these new rules. If effective planning is not received, individuals may find that their pension gets swallowed up by income tax charges, particularly if they plan to continue working in any capacity whilst drawing down the funds.”

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