Five years of pension freedoms: crisis ‘wreaks havoc’ on retirement plans
The new tax year in April 2015 marked a complete overhaul of the retirement landscape as those approaching retirement were given unfettered access to their pension pots.
Anyone aged 55 or over has the ability to access as much of their pension savings as they want with the first 25% withdrawal being tax-free. The remaining 75% is subject to the person’s marginal rate of income tax.
Pension freedoms gave retirees more flexibility and effectively removed the requirement to buy annuities.
Five years on and the total value of flexible withdrawals from pensions has reached almost £33bn, according to the latest statistics from HM Revenue and Customs (HMRC).
But behind this headline figure, how are those approaching retirement accessing their money and is it what the industry predicted?
The most recent Retirement Income Market Data for 2018/19 published by the Financial Conduct Authority revealed that nearly 355,000 pension pots were fully withdrawn – that’s around half of all plans accessed for the first time. The average value of pots fully withdrawn was £13,000.
This level of full withdrawals is consistent for all three tax years and the data also showed more people are shunning annuities in favour of drawdown.
Around a third (191,000) of plans entered income drawdown and weren’t fully withdrawn while plans used to buy an annuity accounted for 11% of the market share (73,977), down from the 12% market share in 2017/18 and 13% in 2016/17.
The FCA stated that the market for annuities is very concentrated, being bought from 23 providers with the top five providers accounting for 80% of annuity purchases.
By contrast, plan holders entered drawdown with over 100 provider firms and the top five providers accounted for only around half of the plans.
However, one major area of concern is that nearly half of all plans were accessed without advice or guidance being taken by the plan holder.
In fact, the Association of British Insurers (ABI), the voice of the long-term savings industry, warned that the rates at which people are withdrawing cash from their pension could see them running out of money in retirement if they don’t have other sources of income.
Since the freedoms were introduced, 40% of savers have withdrawn money at a rate of 8% or more a year, far higher than the recommended 3.5%.
The pension freedoms placed greater responsibility on savers to ensure they make the right choices for their retirement but further reforms and safeguards are needed.
As such, it called for action to help future-proof pension freedoms including later life reviews and mandatory risk warnings for people considering transferring from valuable defined benefit schemes.
At the time of the warning in February, Huw Evans, ABI director general, said: “The jury is still out on the success of the pension freedoms. We will only be able to judge their true impact decades from now, once it is clear whether those who have exercised their choices have the retirement they were hoping for.”
Big withdrawals and negative investment performance
With around a third of people accessing their pension pots but not withdrawing the full amount, the coronavirus is wreaking havoc on the markets and for pensioners.
Tom Selby, senior analyst at AJ Bell, said: “Although it is difficult to judge the sustainability of withdrawals without knowing people’s individual circumstances and overall wealth, a market characterised by people taking an income of between 4 and 5% who tend to have multiple sources of income may appear of little concern – particularly during a period where markets have risen at a healthy rate.
“However, the coronavirus sell-off has changed everything, ripping a double-digit hole in millions of savers pension plans. While those who are building a retirement pot should have decades for their funds to (hopefully) recover value, people drawing an income already will likely have to adjust their spending expectations.
“This will particularly be the case for people in the early years of retirement who took significant withdrawals from their fund just as the current crisis hit. This combination of big withdrawals and negative investment performance – often referred to as ‘pound-cost ravaging’ – can wreak havoc with people’s retirement plans.
“While it may be tempting for some to plough on regardless, such an approach will leave you at significant risk of running out of money.”