Don’t take pot luck – get advice

Most advisers who specialise in this area will have a good sense of whether their model will work in the new regime or whether it needs tweaking. And with Baroness (Ros) Altmann in place as the new pensions minister we can be sure as an industry that the government will maintain a relentless focus on the outcome for our customers.

Recently, we have noticed several broad trends among clients, some more surprising than others.

Firstly, and least surprisingly, those with modest pension pots of up to £30,000 are opting to cash them in, rather than take an income.

Normally this should be a simple process with not much of a requirement for financial advice.

But the rush to cash in pension pots has caused some hiccups along the way. Despite the availability of the government’s Pension Wise service, we are still seeing many over-55s misunderstanding the implications of the freedoms for their tax liabilities. This issue is coming up time and again, regardless of the size of peoples’ pension savings.

For example, if the provider has not received the most up-to-date P45 from a client, they may default to using the emergency tax code, meaning the client may be faced with a larger-than-expected tax bill.

It becomes even more complicated for those clients over the age of 55 who wish to access their pension pot while still working – which is a substantial proportion.

The taxable element of any extra income from their savings can push some individuals into a higher marginal rate of tax. This unwanted side-effect can often be mitigated by spreading out withdrawals over time.

There is a role here for guidance and potentially even advice on this issue, particularly for customers with larger savings or multiple pension pots. Whether the client releases his savings over a number of years using drawdown, uncrystallised fund pension lump sums or fixed-term annuities can make a very significant difference to how much he gets from the savings, fully justifying the advice fee in many cases.

Ahead of the changes, we had an expectation that those with more mid-range pension pots would opt for guidance rather than the advised route.

But many customers with pots of this size are also benefiting from advice.

One such client, for example, asked how best to use her fairly modest pension pot (£62,000). An ex-teacher, she received around £11,000 a year from the Teachers’ Pension Scheme, but she wanted to release some cash for a holiday, and to supplement her income until she reached the state retirement age of 66 – when she would gain additional income.

In this case, advice allowed the client to plan her retirement in stages. She used the 25 per cent tax-free cash allowance to fund her holiday, and it was recommended that she used the remaining £46,500 to buy a fixed-term annuity to take her up to the state retirement age.

The guaranteed maturity value at the end of the fixed term provided her with a taxable lump sum which she planned to use for further holidays.

This example illustrates how customers may have access to different pension pots at different stages of their retirement, meaning their financial circumstances will change. Choosing the right products can provide the flexibility needed to cater to these changes, and, indeed, fixed-term annuities are proving a popular option for those wishing to supplement other income over a shorter period of time.

Some straightforward cases do not justify the extra cost of financial advice, especially when customers are proactive in doing their own research. But it is not the clear-cut case that many were expecting, of drawing lines in the sand based solely on the overall size of a client’s pension savings to determine when they should opt for guidance, and when it is worth them investing in advice.

However, as a rule of thumb, the larger the pension pot, the more options a client has. And while the ability to take the 25 per cent tax-free cash allowance can seem like an obvious choice, selecting a product for the rest of a pension pot is more difficult.

A client with a larger pension pot of £265,000 recently sought advice on this decision. He was 58, and intended to remain working until he was 66. However, he wanted to withdraw his tax-free cash allowance in order to repay his mortgage and reduce his expenditure.

In this case, we advised him against taking any additional income as this would only increase his tax bill. He was then able to use the remainder of his pension pot to create growth over the following eight years, at which point he will be able to reconsider his options.

Giving advice to a client requires thorough research into all the terms and conditions of their packages with providers, and the upfront expense of advice often pays dividends. Investigations for another client with a similar-sized pot uncovered that one of his pension providers allowed him to take 38 per cent tax-free cash – rather than the 25 per cent normally available. He was advised to take the larger allowance with his existing provider, rather than transfer his fund and risk losing the benefit.

In a positive sign for the market, we are beginning to see a growing appetite for clients to pay for advice. Furthermore, it is clear that the complexities of the new options on offer to customers, and the importance of managing tax, mean an advised service has a lot to offer for clients – even if their pension savings are modest.

Howard Hill is a pension income specialist at Age Partnership

Key points

Those with modest pension pots of up to £30,000 are opting to cash them in, rather than take an income.

Many over-55s are misunderstanding the implications of the freedoms for their tax liabilities.

The larger the pension pot, the more options a client has.