Pension freedoms to spark £5bn exodus: the risks

Concept of troubled finances piggy bank with hole being sawed from under neath

With just one month to go before new pension freedoms transform the pensions landscape, one expert warns that 6 April could trigger an exodus from pensions.

He estimates that around £5 billion will be withdrawn from pension savings into annuities, drawdown and in ad-hoc cash withdrawals. The resultant frenzy will not only push providers to the limits of what they can realistically deliver, but will also put hundreds of thousands of pensioners at risk.

The figures come from Tom McPhail, head of pensions research at Hargreaves Lansdown, who is concerned that the government has not done enough to protect 400,000 pensioners from the kinds of risks that could destroy their finances for the rest of their lives. What's even more worrying is that the authorities won't have the slightest idea how many pensioners are falling prey to these risks, because they have chosen not to monitor it.

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McPhail is concerned that the government hasn't paid enough attention to the risks of fraud when granting these freedoms. He told AOL that he is concerned that fraudsters will target pensioners, because they know they have a lot more money at their disposal.

He explains: "It's going to be easier for people to persuade pensioners to take money out of their pension and invest it in something else, and when they have been persuaded to make a poor investment, it's going to be harder to prove they have been a victim of fraud. The government has really neglected this fraud risk, because it was so focused on the risk of people impersonating their pensions guidance service."

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Pensioners don't have to be a victim of fraud to be damaged by the changes: they may simply make a poor decision. McPhail told AOL that not enough had been done to give pensioners the information they need in order to make a decision. He explains, for example, that most people don't understand their tax position.

He says: "We know that most people misjudge their tax liability when they take cash from their pension. If they consider tax at all they might think 'I'm a 20% taxpayer, so I'll pay 20% on the lump sum.' They don't realise that if they take out a large lump sum, it could push their annual income into the higher tax bracket, so they will pay 40% on some of it." He recommends using a tax calculator when planning for a lump sum.

He is also expecting a flurry of people transferring from defined benefit pensions to defined contribution schemes - in order to take the money out. He says that in some cases, where it's a small amount of money in an old scheme, with a generous transfer offer, it could be worth it. However, he has seen transfers being offered to people who would need to reinvest that money and earn 20% a year on it to generate the same income - which is a terrible deal.

The Treasury isn't particularly concerned about this group of pensioners. They recently estimated that about 35,000 people might want advice on transfers from Defined Benefit to Defined Contribution pensions after April 6. However, McPhail believes this is a massive underestimation, adding: "Our research has indicated that up to 500,000 people are actively considering transferring across."

He urges anyone considering a transfer to get advice, as it's notoriously difficult for anyone other than an expert to calculate whether you are better off with the defined benefit pension or the transfer you have been offered.

No idea

What's most alarming about all these risks is that nobody is keeping an eye on what happens when the freedoms are granted. There could be an alarming number of transfers from robust final salary schemes; there could be an overwhelming number of people who cash their pensions in so they can invest in a dodgy scheme being sold to them by a fraudster; or there could be a massive withdrawal of cash which leaves thousands more people turning to the government for more help later in retirement. Any of these things could happen, and the government wouldn't know about it.

McPhail adds: "It's really irresponsible of the government not to track the data: nobody will know what is happening. They told me that they will get an idea from the tax receipts, but getting an idea of things and actually knowing what's going on are two very different things. At some point, maybe under the next government, or the one after that, someone is going to walk into the Treasury and say: 'What's been going on? What happened to all the money?' And nobody is going to have a clue."

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Pension freedoms to spark £5bn exodus: the risks

If, like many Britons, you have failed to save the cash you need to maintain a comfortable standard of living in retirement, one option is to sell your home and downsize to a smaller property, using the money leftover to cover your living costs.
If moving out of the family home is too much of a wrench, however, the good news is that equity release schemes allow you to stay in your house or flat while still using the equity built up in it to provide some extra cash. The downside of the schemes, which work a bit like mortgages, is that you may not have much left to pass on to any children or other relatives.
But that's a small price to pay for a reasonable standard of living. For more information, try Age UK on 0800 169 6565.

Choosing the right annuity can have a significant impact on your retirement income. And as with most pensions, you automatically have what's called an 'open-market option' (OMO), you can scour the market for the highest annuity rate.
It is worth checking what your pension provider is offering first, though, as some companies offer guaranteed rates for existing customers that are likely to beat those available elsewhere. The Pensions Advisory Service on 0300 123 1047 is a good place to get some free advice.

On retirement, most people convert their pension fund into a guaranteed income annuity that pays out the same amount every month for the rest of their lives.
However, you can also choose an increasing annuity that pays out smaller amounts in the first few years but offers larger payments further down the line. This may prove a wise move if the rate of inflation remains at over 2%.

It is now easier to work later in life because the "default retirement age" has been scrapped.
People approaching retirement age and worrying about money can therefore choose to work for a few years longer - potentially transforming their financial situation. Other than the extra income from working, these people can look forward to higher state pensions, and higher annuity rates due to their greater age.
They can also benefit from bigger tax allowances and the fact that they no longer have to pay National Insurance contributions. Check out this nidirect website for more details.

You could get a much better rate with an impaired-life annuity if you have a medical condition that is likely to reduce your life expectancy.
Incredibly, even snoring, which is a common symptom of Sleep Apnoea could have an impact.
According to figures from MGM Advantage, a man with this condition could receive an extra £12,000 retirement income over the course of their retirement - or £571.44 extra money each year. Click here to find out more.

To maximise your retirement income, it is vital to ensure that you are receiving all the benefits to which you are entitled. These include the basic State Pension, and in some cases, the additional State Pension.
If you are on a low income, you could also qualify for the guaranteed element of Pension Credit, while those with some savings may get the savings element of this benefit. For more information about these and other benefits such as the Winter Fuel Payment, click here.

Many older couples rely on the pension income of one person - often the man. Should that person die first, the other person can therefore be left in a difficult position financially.
One way to prevent financial hardship for the surviving person is to take out a joint life annuity that will continue to pay out up to 67% of the original payments to the surviving partner should one of them die.
The disadvantage of this approach, however, is that the rate you receive will be lower. Again, the Pensions Advisory Service on 0845 601 2923 is a useful first port of call if you are unsure what to do.


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