Pensions in 2015 – what is going to happen and what should investors do to prepare?

26th December 2014

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Hargreaves Lansdown’s head of pensions research Tom McPhail sets out the challenges facing pensions next year and rates the level of uncertainty about the various changes. Crucially he also sets out what investors can do to prepare.

Whilst 2014 has been one of the most turbulent years that anyone working in pensions has ever experienced, there is every possibility that 2015 will see just as much disruption. Here is our brief list of the key events and issues to watch out for.

What to expect from 2015

6th April 2015 – the new freedoms go live

We get Easter Monday, the new tax year and the pension freedoms, all on the same day.  It’s like all our Christmases come at once. The legislation itself is largely done and dusted, though there does remain the possibility of some last minute tweak if the Treasury realises it has overlooked something important. If you want the details of the specific changes made by the Taxation of Pensions Act and the Pension Schemes Bill, get in touch.

Uncertainty factor: Low to medium

Free retirement guidance

The new free retirement guidance will be officially launched. The Chancellor has promised every retiring pension investor will have access to free, impartial retirement advice. It will be provided by The Pensions Advisory Service (over the phone and online) and the Citizens Advice Bureaux (face to face). TPAS is working flat out to prepare for this responsibility, however the service is likely to be limited both in its scope and in the take up from the public. Even if the service is ready and CAB has trained all its advisers, the actual breadth of the guidance will be limited and it is quite possible that very few people will use it. If it does enjoy unexpectedly high demand, TPAS and CAB may not be able to cope.

Uncertainty factor: High

New retirement income products

There has been much discussion of new retirement products. We may in time see annuity products which offer variable payments and cash withdrawals but nothing has surfaced yet. We may also see guaranteed (or even collective) drawdown, giving investors the best of both worlds; high returns and security but nothing seems to have really emerged yet. There will no doubt be more development work around and after April.

Uncertainty factor: Medium

New retirement income investment strategies

A simpler approach to the guaranteed drawdown is one which uses strategic asset allocation and income distributions to give investors a return which is somewhat higher than the natural yield generated by the underlying investments. However the only way to do this is to eat into the capital and that in turn means risking running out of money. It also means there is not necessarily any guarantee, which makes everything simpler for the manager but less certain for the investor. The trick then is to make sure everyone understands exactly who is responsible for what and where the buck stops if anything goes wrong (like running out of money).

Uncertainty factor: Medium

Final salary scheme transfers

Private sector final salary scheme members have 3 broad options: stay where they are; transfer to a Defined Contribution scheme; use Trivial Commutation to take their money back (only applies to small pots). If transferring to a DC scheme, they need to take advice first. What we don’t know at this stage is how many people might want to exercise this freedom and how well the industry will cope with the demand. Current expectations are that most people should stay where they are but it is far from certain they’ll see it that way themselves.

Uncertainty factor: Medium to high

The election

At one level politics is already taking on an end of term feel, as politicians abandon Westminster to tend to their constituencies. The problem for individuals and businesses out here in the real world trying to plan their finances and those of their companies and employees, is that the national political agenda is going to get increasingly febrile and unpredictable. The election itself is impossible to call; it is entirely possible we’ll have more than one election this year.  So trying to pre-empt acts of political opportunism, populism and general idiocy is more challenging than ever before.  Not only do we not know what government policy might look like 6 months from now, but the cast list of politicians who could be taking influential decisions in the Treasury and DWP in June is now long enough to stage a decent Broadway musical.

Uncertainty factor: Off the scale

The tax treatment of private pensions

Following on from the previous point, a new government could mean many things. Changes to the annual and lifetime allowances; a change to the tax treatment of pension contributions or investment growth; a reversal of some of the budget freedoms; pot follows member and scheme governance: All these are up for grabs from the morning of 8th May onwards.

Uncertainty factor: Off the scale

The regulation of the retirement journey

To its credit, the FCA has confirmed its intention to rethink the retirement journey. The old style wake up packs and the ABI’s Code of Conduct will hopefully, finally be consigned to the ignominious dustbin of ‘how not to communicate with human beings’. The FCA’s development work in how to regulate retirement income communications is critical to ensure that investors get the right opportunities to make the right decisions. They’re making the right noises, our only worry is that we have been here before, more than once.

Uncertainty factor: Low to medium

Will pension schemes be ready for the reforms?

Some will, some won’t. Some of the more well managed pension providers will undoubtedly be ready well in time for April (yes, we are including Hargreaves Lansdown in this category). Many others will not. Expect to see a multitude of complaints emerge as investors find they have been handed the keys to pension freedom, however the lock has rusted up.

Uncertainty factor: High and Low

Misselling reviews

Early in the New Year we should hear some Ombudsman adjudications relating to illegal pension unlocking. Other misselling reviews (NB this is just a guess list so don’t read too much into it) could centre around the FCA’s investigations into the sale of non-enhanced annuities to those who had medical conditions; high charging legacy individual pensions; the past decisions relating to contracting out; drawdown investors who ran out of money.

Uncertainty factor: High

What should investors do to prepare?

Plan ahead

The new freedoms go live on the 6th April but anyone wanting to make use of them when they first become available should plan ahead. There is widespread expectation of service disruptions, even assuming your current pension provider has developed the necessary systems and services to meet their investors requirements; many are still in stage one planning.

Any investor looking to use drawdown or buy an annuity around April 2015 should be planning now, identifying which products they might want to use, transferring funds if necessary and making sure they aren’t going to be left waiting in vain. Anyone wanting to use drawdown can set up an arrangement ahead of April without losing any benefits (unless their existing pension carries an early encashment penalty).

Priority: High

Check your tax position

The new freedoms make it very easy for even modest earners to accidentally slip into paying higher rate tax. Our research shows that many investors don’t realise any withdrawals in excess of the 25% tax free sum will get added to their income. For example, someone earning £20,000 a year who cashed in a £30,000 pot would end up paying around £4,600 in tax.

Priority: High

Blend your income

Our research shows that most investors want some security and some flexibility. For most people therefore the right answer is likely to be a combination of an annuity and a drawdown plan, providing a blended income. The trick is to plan ahead and identify how much of your pension pot you want to allocate to a guaranteed income and how much you want to keep invested in the market.

Priority: Medium to high

Complete a death benefit nomination form

From April you can nominate any beneficiary to receive your pension fund on your death. It doesn’t have to be a family member or financial dependant. The trustees will only know for sure who you want to receive the money if you have notified them in advance. In a minority of cases, if they can’t identify who to pay the money to it could end up in your estate, in which case it would be subject to Inheritance Tax, as well as a 45% tax charge when it leaves the pension.

Priority: High

Maximise contributions

Politicians are unable to resist tinkering. For higher earners, there is always the possibility that a new government could curb the tax breaks on pension contributions. For lower earners there is just the outside possibility that a Liberal Democrat Chancellor (stop laughing at the back there) could introduce a higher rate of tax relief for all, in which case they might be better off waiting until the rules have been changed (assuming they think this is a likely outcome).

Priority: High (unless you’re a basic rate taxpayer and you think Steve Webb will be the next Chancellor)

If in doubt, take advice

Especially if you have any final salary scheme benefits (and don’t forget to find out what your state pension entitlement might be). The reforms are pretty simple but the product and investment choices are complex. Do your own research first but if you’re in any doubt, don’t be afraid to pay an IFA for help, it could be money well spent.

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