2014 has been a momentous year for pensions, with possibly the biggest changes in a generation announced.
However, according to the man overseeing the new rules, Pensions Minister Steve Webb, some pension savers will “make the wrong choices” and end up less well off in retirement.
Speaking at a recent conference Mr Webb said: “”This coming April some people will get it wrong. They will make the wrong choices. They will get a worse outcome than if they had, for example, fully taken up our guidance or paid for advice, or if they had bought an Annuity.”
So how can you avoid being one of them?
Here are seven ways:
#1: Don’t take out too much too soon
For most people their pension is there to give them an income for their rest of their life, it might also need to continue paying to their widow or widower.
Taking out too much money too soon, might mean you run out of cash before you die, leaving you unable to pay your bills.
The problem is made worse by two other factors. Firstly, we routinely underestimate how long we will live and secondly, if you take too much out when stock markets are falling, your pension will get hit from two sides.
If you are relying on your pension, be careful about taking out high levels of income or large lump sums, you could be left struggling to make ends meet.
#2: The grass isn’t always greener for members of Final Salary schemes
The thought of taking out lump sums from a pension has got many people dreaming of expensive holidays in far flung places and new cars.
However, the new rules don’t apply to Final Salary pensions, which are also known as Defined Benefit schemes. These arrangements provide a guaranteed income, which is generally index linked and continues to your spouse on your death. They are widely accepted as being the most attractive type of pension available.
We know that many members of Final Salary pensions are tempted to consider transferring their benefits, giving up the guaranteed, index linked income in return for better access to their pension. Some people have also been convinced to transfer in the hope higher investment returns and a better income in retirement.
Don’t make this mistake. Transferring out of a Final Salary pension is almost always a bad idea, which will leave you worse off in retirement.
#3: Income Drawdown always comes with risks
Most experts will agree that fewer Annuities will be bought as a result of the new rules and more people will use Income Drawdown.
This option allows you to keep the money invested and withdraw income; the amount you take out can be changed each year to suit your needs.
Taking out too much money too soon is of course a problem, but there is also the issue of risk, it is impossible to use Income Drawdown without exposing your pension pot to risk.
If you invest some or all of your Income Drawdown fund in stocks and shares, as most people do to try and get a better return, you run the risk that the value of your fund could fall if the stock market fails to perform or you choose badly performing funds. Conversely, if you invest in Cash, perhaps via a SIPP (Self-Invested Personal Pension) you run the risk that your fund will grow more slowly than inflation and the returns could well be less than you take out.
#4: Annuities aren’t “rubbish”
Since the Budget there has been something of a backlash against Annuities. But for many people an Annuity is still the right option, especially if they are looking for a guaranteed income and a relatively simple solution.
Annuities are often perceived as ‘boring’ and ‘safe’, but that’s exactly what they are intended to be.
Furthermore, whilst Annuity rates have fallen the returns are surprisingly attractive, especially if you qualify for an Enhanced Annuity.
Annuities certainly still have their place; don’t let anyone tell you otherwise.
#5: If it’s too good to be true, it probably is
As people get greater access to their pension they might be tempted to take money out to invest in alternative ways. Indeed there is never a shortage of people selling inappropriate investments, promising to give high returns for no risk.
If an investment looks too good to be true there’s a reason, it probably is!
If in doubt, take independent financial advice from an adviser regulated by the Financial Conduct Authority (FCA).
#6: Plan carefully to avoid paying too much tax
The thought of taking as much out of your pension as you like might sound attractive, but if you’re not careful you could be left with a lot less money than you planned on getting.
Any money you take out of your pension above the 25% tax free lump sum will be added to your other income and then taxed. Therefore, if you take out money when you are still working, you could end up paying 40% or even 45% tax.
The Government has predicted the new measures will raise billions of pounds in extra tax revenues over the next few years; you should plan carefully to make sure you contribute as little as possible from your pension.
#7: Guidance isn’t advice
If you retire after April 2015 you will be entitled to free ‘guidance’ to help you make the correct decisions.
Despite the fact the ‘guidance’ will be offered by The Pension Advisory Service (TPAS) and the Citizen’s Advice Bureau (CAB) it isn’t regulated advice; yes, we know it’s confusing!
‘Guidance’ will provide you with generic information on the options available to you. It will not recommend which product to buy, from which insurer and if appropriate how to invest your pension savings; only a regulated financial adviser can do that.
‘Guidance’ will certainly be useful, especially if creates a new generation of more informed pensioners. But it doesn’t replace the job of a financial adviser, which many people believe is vital to a prosperous retirement.
Worried about making a mistake? We’re here to help
If you want to take advantage of the new rules, but are worried about making a mistake, we’re here to help.
Call one of our highly qualified and experienced advisers on 0115 933 8433 for an initial chat about your circumstances. Alternatively, email firstname.lastname@example.org