Millions are confused about their retirement options

14th January 2015

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Millions of  pension savers do not understand the retirement options available to them, a study has found.

A survey by ILC-UK of 5,000 people aged 55 to 70 who are yet to draw down on their private pension found just 35 per cent of those with a defined contribution pension understand what income drawdown is.

Defined contribution pensions are those that provide no guarantee of the amount you will receive in retirement, which is dependent upon how investments perform.

In order to guarantee a certain income using a DC pension pot, retirees would need to purchase an annuity, but only half of those with a DC pot understand what an annuity is quite or very well.

Savers with final salary or defined benefit pensions do not need to buy an annuity with their main savings pot as it will automatically be converted into a pre-agreed income when they retire.

Enhanced annuities provide extra income to those with lower life expectancy because of lifestyle factors such as smoking, or because of existing medical conditions, however, just 20% of those quizzed understood what purpose the products served.

This compares to 90% of people who said they understand what a mortgage is.

Women were consistently less financially aware than men on all measures and are therefore most at risk of confusion from the new pension freedoms

Ahead of new pension freedoms that will come into force in April, allowing retirees complete flexibility over how they use their retirement savings,  nearly 70% of all those with DC pension savings favoured using their pot to deliver a guaranteed income, particularly an income protected against inflation, while just 7% said that paying for big ticket items such as holidays or a car was most important, and 5% said paying off debt was the priority

The research also exposes a lack of understanding of the tax implications of the Government’s flagship pension freedoms set to be introduced in April.

Only 20% of people with a DC pot said they understand what a marginal tax rate is.

When pressed on how to reduce their tax burden when withdrawing money from their pension pot, only half gave the correct answer that it should be withdrawn in small amounts over a number of years. One in ten wrongly thought that the best thing would be to withdraw as one lump sum.

The research also found that 60% of respondents had not made a plan for retirement. Even among those less than one year from retirement, 40% had not made a plan.

Dr Ros Altmann, retirement expert and co-author of the report, said: ” In the short-term, policymakers must focus on ensuring take up of the free financial Guidance with a widespread marketing campaign,building within the Guidance process an effective hand-off to other forms of support including regulated financial advice.

” But in addition, there is an urgent need for a contingency plan to support those who choose not to go through the Guidance process as well as those who do take-up the Guidance process but are still at risk of making poor decisions. Over the longer term, financial education for all is needed, perhaps embedded from an early age into pension auto-enrolment schemes, to improve the nation’s financial capability.”

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