With the radical implementation of the pensions freedoms two weeks from now, advisers and providers have been preparing themselves for profound changes in consumer behaviour.
Despite the industry broadly welcoming the changes, recent weeks and months have been witness to a host of warnings that consumers should err on the side of caution, take advice or guidance where possible and not rush into any decisions.
Pensions minister Steve Webb has openly suggested that the general public should “stay in bed’’ on the morning of the reforms or, in other words, allow time for contemplation. Of course, all of this suggests concern that consumers will do the opposite and dash to take the cash.
Providers have been adding in layers of protection for consumers above and beyond the Financial Conduct Authority’s ‘second line of defence’, which has already proscribed for providers a system of tailored alerts to prevent consumers making ‘bad’ or ‘wrong’ decisions.
Old Mutual Wealth, Zurich, Royal London and Aviva have all revealed to FTAdviser they will be adopting additional protections.
For Claire Trott, head of technical support at Talbot and Muir, while these measures are laudable, the important thing is that individuals actually take formal financial advice.
She highlights that withdrawing money from a pension scheme is not just about taking a lump sum and reducing future income, it is also a complex tax calculation and has consequences for future contributions, given the new money purchase annual allowance of £10,000.
Moreover, she says each client will be in a different situation with their current scheme which needs to be review - and will have different circumstances outside of the basic pension considerations which could sway a decision either way.
“You may be entitled to better benefits in the scheme you are in such as enhanced tax free cash and this could be lost should you look to cash it all in.
“There could be many good reasons to take some or all of a pension, but it isn’t just related to the pension itself: other issues need to be taken into account such as debts and future commitments. If you don’t look at the bigger picture you cannot be sure you will be doing the right thing.”
When taking cash might be right...
Greg Crawford, senior financial planner at Informed Financial Planning believes at a basic level that taking money is the right move when the adviser can simply demonstrate the client has the ability to draw funds now and still maintain their target income and standard of living in retirement.
For Mr Crawford, it would be bad advice to recommend funds be drawn on a whim because the client ‘wants’ as opposed to ‘needs’ something, for example a new car or holiday, unless they have already met all of their needs for income.
Daren O’Brien, director at Aurora Financial Solutions, says that taking money can be ‘good advice’ when it does not impact on any other potential state benefits that the client might receive.
“If the pension pot is small then the client might have been able to access the funds without the new freedoms anyway.
“Taking money is bad advice when it potentially reduces other state benefits that the client might be receiving or may be eligible to receive. It may be bad when a client is risk adverse and believes the fund is better in their account than buying an annuity.”
David Trenner, technical director at Intelligent Pensions, believes that within the context of the new rules it is clear that generally speaking you should only take cash if the amount is small. He says there is one exception to this rule: clearing expensive debt.
“If you are paying huge amounts of interest to a payday lender, or even a credit card provider, clearing these debts will earn you a better return than any fund manager.
“If you are already 55 there is little advantage in delaying the chance to save on huge amounts of interest, but remember that once your pension is gone it is gone for ever unless you start building it up again.
“Ask yourself whether in five years’ time you will be in the same hole, but with no pension to save.”
Tom McPhail, head of pensions research at Hargreaves Lansdown says that in principle one should not take money out of a pension until is needed, though he agrees with Mr Trenner that paying down of debt is may make the decision to take cash the right one.
“Paying off debts is potentially a strong reason for making a withdrawal. Beware of triggering the Money Purchase Annual Allowance, which could be a problem for you in later life if you find yourself with capital available - perhaps from inheritance - and wanting to make a lump sum pension investment.”
... and when it isn’t
Martin Tilley, director of technical services at Dentons Pensions Management says that a pension scheme should always be viewed primarily as a retirement planning tool. It is there and receives the tax breaks on contributions to replace income lost when the individual retires.
He says that as such when replacement income is required and the individual is over the age of 55, a plan of income can be established.
Mr Tilley notes that first and foremost an individual should not draw out money just because it is available, saying that without proper financial planning the consequences could be “disastrous”, especially if it is being taken to invest in non-pensions alternatives.
He says that individuals should look out for non-regulated promoters of inappropriate investments promising returns that appear too good to be true.
“There are also some instances when drawing income might be disadvantageous from a tax perspective. Drawn income is added to any other income the individual receives in the tax year and lumps could easily take 20 per cent taxpayers into 40 per cent tax territory.
“It should be remembered that the pension scheme is a tax-exempt vehicle for income and capital gains tax.”
Mr Crawford says that money should not be withdrawn simply to hold in a cash account or Isa, as the tax consequences are likely to outweigh any convenience benefit.
“A pension is tax efficient whilst invested, whilst it grows and on death. The consequence of a switch in a tax wrapper should always be considered.”
For Ms Trott, there are times where even if you need to take an income it may be better to wait for at least a short time in order to minimize the tax you will pay, making sure that you aren’t going to inadvertently go into the next tax bracket just to access cash earlier.
“By waiting you could easily save a significant amount of your hard earned pension and make it go a lot further.”
Mr Trenner says that quite simply, if you do not need your cash, you should not take it.
“Tax-free cash will still be available in the future, perhaps to reduce tax when you need income, and in the meantime it will continue to grow tax-free.
“Taking taxable cash to re-invest does not make any sense: you could pay 45 per cent to get at the funds and will then pay 45 per cent tax on the income generated in the current tax year.”
ruth.gillbe@ft.com
