It probably didn’t need a genius to predict that pensions freedoms were always going to be a runaway success. Bestowing savers the ability to take 25% of their pension pot tax-free (a full ten years before most people would have expected it), gave many workers the chance they needed to pay off their mortgage, go on holiday, and yes even buy a Lamborghini. And official statistics largely prove this. Between April 2015-January 2017 a total of £9.2 billion was ‘withdrawn’ by more than 500,000 people, while more recent data (to July 2017), reveals more than half (54%) of all pots accessed were cashed-in in their entirety.
But the question these statistics really pose is ‘success for whom?’ While the economy might benefit from a silver pound-led spending boom, the simple fact is that anyone taking some, or all, of their initial tax-free cash will be at mercy of the HMRC for the rest of their lives, because they now need to make new decisions – choices which (if not done wisely), could see them paying more tax than they need to, so shortening the longevity of their carefully saved up pension pots.
Why? Well, so-called pension ‘freedoms’ actually sentence savers to a life of working out their tax – something very few are skilled at doing. The moment workers access their pension early, even if they only take part of it, they subject themselves to the ‘25% tax-free, with the remainder being treated as taxable income’ rule. Even if savers don’t take their full tax-free amount out at once, but opt for staged payments, 25% will still be taxed, while the other 75% is tax-free. This opens up a whole can of worms. These taxable amounts could be added to other income (like salary if they’re still working), giving most people an additional tax bill – and in some circumstances, it could even tip people into a higher tax bill.
Savers now need to get more financially savvy, because there are so many options they need to consider. If, for instance, worker with a pension pot of £80,000 is prepared to wait till they’ve stop working till they take their 25% tax-free lump sum, they could see a very different scenario.
Here, after taking their tax-free money, £60,000 would be classed as taxable income. But, because they’ve stopped working it’s entirely likely they’ll have no other income coming in (apart from their state pension), and if this is the case, if they take out their £60,000 slowly – it’s entirely possible they could end up paying no tax at all (given the personal tax allowance is £11,500 for 2017/18).
But this isn’t the only consideration savers need to weigh up. Any form of draw down means that once their money is gone, it’s literally gone. At least with buying an annuity, a set amount guaranteed, no matter how long a person lives. Savers can still take their 25% tax-free amount, then buy an annuity with what’s left of the remaining 75%. Although tax is paid on annuity income, it’s at PAYE rate – 20% on any income between £11,501 and £45,000 – ie as if that person is still earning a wage. So again, there will be yet more options to deliberate. And this isn’t including the fact that what can sometimes be forgotten about is the fact savers can continue to benefit from tax-free growth of their fund if their pot isn’t accessed at all. An untouched fund that’s allowed to grow for potentially another decade could convert into a hefty annuity. Even money that is accessed is still growing – but at what rate? Again, individuals need to look at this too, to see the impact of taking too much out too early.
All of which explains why the only thing that’s really clear about pensions at all, is the need for computation tools to take the strain. It’s almost impossible for ordinary men and women to work out these sorts of conundrums themselves. Short of being a financial planner, the machinations around fund growth, impact on pot longevity as different amounts are accessed, or what happens when pots are annuitised or turned into drawdown, are far too complex.
Pensions were supposed to be getting simpler for people. Starting one off has indeed become easier, but without some form of modeling help, the brainpower that’s now involved for accessing this cash later in life is now arguably too much. Savers may have wanted to get at some of their money early; the consequence of this is a need for working out how the rest of it is impacted. Fortunately technology is here. It’s frightening to think what might happen without it.