Talking Point  

Pensions freedoms - where are we now?

  • To understand what has happened since pension freedoms.
  • To learn what the average investor is doing.
  • To grasp opportunities for advice post-freedoms

“It is essential for an IFA firm to have a very clear process in place. We are not there to stop people doing what they want to do with their pensions, but they have to understand the risks that they are taking.”

Back in August, Hymans Robertson partner Patrick Bloomfield cautioned DB members against succumbing to the “allure” of cashing in their pensions, as low interest rates and yields meant it could be impossible to find a better deal elsewhere without considerably more personal risk.

Also members of defined benefit schemes who transfer out and then die within two years could be subject to hefty inheritance tax charges, paraplanning firm The Timebank's Sean Donald has warned.

But while prior to April 2015 DB schemes were near universally considered superior to DC schemes, as Mike Morrison, head of platform technical at investment platform AJ Bell, pointed out, pension freedoms have opened up the range of things that need to be considered.  

“The ability to access a lump sum tax free, to continue to benefit from investment growth and to pass on a DC pension without incurring inheritance tax, may all be benefits worth considering at the expense of a DB guarantee,” he said.

As the appeal of using annuities as the sole retirement option has waned over the last 21 months, a few new ‘hybrid’ products which blend annuities with drawdown have taken their place.

Hybrid contracts provide useful flexibility, as customers can reduce or even stop the income they receive from the annuity at any time. Any surplus annuity income is reinvested within the drawdown element to be used at a later date.

However Claire Walsh, chartered financial planner at Aspect 8, said she had “yet to see anything particularly compelling” in the way of new products, and Darren Cooke added he believed hybrid products have “limited appeal”.

Drawdown risks

With many more people in drawdown as a result of pension freedoms, that means many more people facing sequence of returns risk.

Sequence of returns risk is a function of volatility. It is the risk of receiving lower or negative returns early in a period when withdrawals are made from an individual's underlying investments. 

The order or the sequence of investment returns is a primary concern for retirees who are living off the income and capital of their investments.

“This is potentially a big issue for clients”, said Darren Cooke, director at Red Circle Financial Planning. “So far we have generally had strong markets over the short time flexible drawdown has been in place, so it hasn't been experienced yet.”

One option, he said, is to reserve a part of the client’s retirement fund in cash so income is drawn from this, not the invested element.