The introduction of ‘Pensions Freedom’ means 2014 goes down as the year pensions were changed forever.
The changes will certainly give you more flexibility when it comes to accessing your pension pot. But despite how the changes are being portrayed by some people, there are serious dangers and pitfalls you need to be aware of.
Here are our top six Pensions Freedoms mistakes to avoid:
Mistake #1: Guidance isn’t the same as Advice
The Government has announced that from April 2015 everyone approaching retirement will be given ‘Guidance’ on the options available to them.
We welcome ‘Guidance’ and hope it means people make more informed decisions, but if you use the service you need to know that it isn’t the same as ‘Advice’.
‘Guidance’ will help you better understand the pros and cons of the different options available to you. But it won’t give you a fully compliant recommendation, produced taking into account your individual circumstances. Nor will it recommend the right product and provider for turning your pension pot into an income.
‘Guidance’ is definitely a welcome addition to the sources of information available to you, but it isn’t the same as ‘Advice.’
Mistake #2: An Annuity might still be the right option
The humble Annuity has had a tough time over the past few months, but for many people it will remain the right option.
If you’re looking for a guaranteed income for the rest of your life, are in ill health, or want a relatively simple solution, an Annuity might still be right for you.
Remember too, you don’t have to use all of your pension pot to buy an Annuity. Why not consider a half-way house, perhaps buying an Annuity to cover your essential outgoings and then looking at other options with the remaining funds?
Ignoring an Annuity is as dangerous as failing to consider all the other options available to you.
Mistake #3: Transferring Final Salary pensions is almost always a mistake
The new freedoms don’t generally apply to Final Salary (also known as Defined Benefit) pensions. As a result there has been much debate around the merits of transferring Final Salary pensions to alternative arrangements, usually a Personal Pension, to take advantage of the new rules.
On top of this, we’ve also seen mounting evidence that members of Final Salary pensions are being targeted by rogue salespeople, trying to sell unregulated investments.
Final Salary pensions give valuable benefits, which are guaranteed, generally index linked and almost impossible to match if transferred into a Personal Pensions.
Whilst there are isolated exceptions, usually when someone is close to retirement and in ill-health, transferring your Final Salary pension is almost always a bad idea.
If you are advised to do so we would recommend you quickly seek a second, and if necessary a third, opinion.
Mistake #4: Income Drawdown isn’t risk free
The new rules, especially those abolishing the 55% tax charge on death before 75, will probably mean more people use Income Drawdown, or Flexible Access Drawdown as it will be known from 2015, to turn their pension pot into an income.
As with any financial product Income Drawdown is right for some people, but not for others. We are concerned that well-meaning pensioners, who want to leave lump sums to their dependents, will now decide to use Income Drawdown, exposing both their capital and income to more risk than they would usually be prepared to take.
For those people who prefer to take no investment risk, it’s also worth remembering that an Annuity can be set up to provide a lump sum on death.
Mistake #5: Don’t forget the tax
The new rules will allow anyone over the age of 55 to take their entire pension pot as a lump sum.
This might sound like an attractive idea to many people previously frustrated by the lack of flexibility when they retire. But taking the whole pension pot as a lump sum could prove to be a very expensive mistake if you forget about the tax you will have to pay.
From April 2015 the first 25% of any money you take from the pot will be tax-free; the rest though is added to your other income and taxed at a rate of 20%, 40% or even 45%.
Taking the whole pot might sound tempting, but if you don’t plan carefully you could be left with a lot less money that you thought.
Mistake #6: A pension isn’t the same as a bank account
Despite what George Osborne might think a pension is not the same as a bank account; in fact to compare them is potentially dangerous.
For most people a pension is a long term investment to provide an income in retirement, the value can rise and fall and you need to plan carefully to make sure you don’t run out of money.
A bank account on the other hand is used to pay your day to day bills, the money is guaranteed (up to £85,000 per person) and the worst that happens if you run out of money is nasty letter from your bank and potentially some unwelcome charges.
Mistake #7: Don’t run out of cash
We’ve saved the most important for last.
Stealing a quote from that famous investor, Warren Buffett*, if you’re a pensioner or indeed close to retirement, rule number one must be: “Never run out of money”.
And rule number two? “Never forget rule number one!”
You might be tempted to take high levels of income from your pension, withdraw lump sums or to make choices which will help your dependents more than you. But when making any decisions the overriding consideration has to be the need to provide an income for the rest of your life and possibly your spouse too.
Running out of money later in life, especially when State Benefits are being cut, really isn’t an option.
*When asked about investing Mr Buffett actually said: “Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.”
We’re here to help
The 7th mistake could easily be not taking advice when you retire.
Your pension pot is probably your largest asset after your house, taking your time to make decisions as well as using an Independent Financial Adviser is vital.
With clients the length and breadth of the UK we’re here to help. If you are close to retirement call one of our retirement experts today on 0115 933 8433 or email info@investmentsense.co.uk
