The Chancellor, George Osborne, recently told the House of Commons that 60,000 people have withdrawn more than £1 billion from their pensions since new freedoms were introduced in April.
Whilst Mr Osborne said that the figures showed Pension Freedoms has been a “success” he went on to say, “…but we have to make sure that people get the best advice…” presumably to stop them making mistakes and falling into some of the pitfalls which await those people who do not fully understand the new rules.
So, if you are thinking of taking money from your pension what are the main pitfalls you should look to avoid? Here are our top eight.
#1: Leaving yourself short of money
You probably paid into a pension so that you could retire and pay your bills in retirement.
Unless something has changed, even with the new found freedoms, don’t you still need the income your pension was going to provide to help you retire?
Of course things might have changed since you set up your pension. But, before you go ahead and withdraw large amounts, take some time to calculate whether or not you will be leaving yourself short in retirement.
#2: Paying too much tax on the amount you take out
The first 25% of any money you take from your pension is tax-free; the rest will be added to your income and then taxed, at a rate of 20%, 40% and perhaps even 45%.
The Government estimates it will raise billions of pounds in tax from Pensions Freedom. We are concerned that many people don’t understand the tax implications and will end up with a smaller lump sum than they originally thought they would get.
There are ways to reduce the amount of tax paid when withdrawing lump sums, for example, staggering the payments over two or more tax-years. But it takes careful planning.
#3: Thinking it will be easy to get your money
Pension providers have been inundated with requests for lump sum payments and many are struggling to cope, causing large delays in payments being made.
There is also evidence that some pension providers are insisting that you take advice from a financial adviser before accessing your cash.
Naturally we believe that high quality financial advice is a good thing and could save you from making an expensive mistake (see #8). However, if you are planning to take a lump sum from your pension make sure you leave plenty of time and plan ahead. It will take longer than most people think it will.
#4: Losing out on valuable guarantees – part one
Pension Freedoms are not available to those people with Defined Benefit, also known as Final Salary, pensions.
Typically workers on organisations such as the NHS, local authorities or larger companies have these types of pension and they provide valuable guaranteed income, which is often index linked.
There is concern that some people with these types of pensions will give up valuable guarantees and transfer to a Personal Pension so they can take advantage of the new freedoms without realising what they are giving up.
Whilst a lump sum might sound attractive now, before you go ahead and transfer out of a Final Salary pension you must understand exactly what you are giving up and take advice as to whether it is the right course of action for you.
#5: Losing out on valuable guarantees – part two
Some Personal Pensions, particularly those take out in the 1990s or before, may have included a Guaranteed Annuity Rate (GAR).
Now, don’t switch off just because we’ve mentioned the word ‘Annuity’ this is important!
GARs can be very valuable with rates well in excess of those available today or indeed the returns from many investments.
Before you move your Personal Pension, or take a lump sum, ask your existing pension provider to confirm whether or not you have a GAR. Look hard in the small print too, they are often hidden.
Missing out on a GAR could be a very expensive mistake.
#6: Thinking that Annuities are ‘bad’
Annuities have had a bad press over the past few months with the focus being on flexibility and the new freedoms.
However, if you want a guaranteed income for the rest of your life, which you know can never be taken away; an Annuity still might be the right solution for you.
Sometime the old ways are still the best!
#7: Not taking advice
Some elements of the press have railed against the benefits of receiving financial advice when you take money from your pension.
However, investing in expert advice could well make you money in the long run.
An adviser can help you spot these eight pitfalls, plus others and suggest alternative options to help you achieve your goals.
#8: Falling victim to a scam
Unfortunately Pensions Freedom seems to have given scammers a new lease of life.
From unsolicited phone calls purporting to be offering Government appointed advisers, to scams offering high guaranteed returns, we are worried that unsuspecting savers, who believe pensions are ‘bad’, could be tempted into making poor choices, which will ultimately leave them far worse off in retirement.
Remember, never do business with a cold caller and if it sounds too good to be true, then it probably is and you should walk away.
We are here to help
Pensions Freedom will benefit many people, but there will undoubtedly be losers.
We’re here to help make sure you don’t fall into these pitfalls and make Pensions Freedom work for you.
Call Bev Stoves or Sarah McCarthy today on 0115 933 8433 or email info@investmentsense.co.uk
Please note
Any reference to tax relief is based on current HM Revenue & Customs guidance and is dependent on your individual circumstances which may change
