7th April 2014 by Patrick Connolly
The proposed changes to pension rules announced in the Budget surprised just about everybody. Those with personal pensions or other defined contribution pension schemes will have far more choice about how they take their benefits.
While buying an annuity has been the default option for most people looking to take income from their pension, many have begrudged locking in to the miserly rates we’ve seen since 2008. This lack of perceived value has stopped people investing more into pensions.
It is difficult to argue against a new regime which will provide more flexibility and greater choice. However, with more freedom comes more opportunity for people to make the wrong choices. This is why there will be an even greater need for good quality independent financial advice.
Many will be sorely tempted to take the money out of their pensions when faced with what they might see as a choice between a significant lump sum or an unattractive level of income through an annuity.
There is no doubt that some will treat this ‘windfall’ recklessly, perhaps on a blow out round-the-world cruise while they still have their health, or something equally as extravagant. Others will simply make the wrong choices.
In the current low interest rate environment it is difficult to generate a decent level of income without taking risk. This could mean that capital is eroded, perhaps quickly. Another common problem people make is under-estimating their own longevity. At age 65 most people are not ‘death’s door’ and many will have 30 or more years left to live. This means 30 or more year’s income will be required.
In his Budget speech George Osborne said that those taking pension benefits would get face-to-face advice. This has been tempered down to face-to-face guidance. There is an important distinction here. Financial advice is tailored to an individual’s needs, guidance can be little more than generic information.
In theory it is useful to give people a helping hand when they are making what are likely to be crucial financial planning decisions which could affect their future standard of living. However, if the guidance is provided by product providers or other organisations, they are unlikely to risk any future comeback by recommending anything other than the safest possible option – yes, buying an annuity. At least the guidance should be to shop around for an annuity rather than just sticking with their pension provider.
If the guidance infers other higher risk options are appropriate, such as drawdown or taking the money out and investing elsewhere, then what help is going to be provided to the individual in the future to ensure their investments remain on track? The answer is likely to be none unless they are prepared to pay for it.
For all of the freedom that the new pension rules will bring, individuals will essentially have three choices. The first is to buy an annuity, which will give them a guaranteed income for life. The second is to work with a financial adviser, ideally an independent financial adviser, who can evaluate the various options, decide which are the most appropriate and provide regular reviews to ensure everything remains on track. The third is to make their own decisions and select an option other than an annuity. This final scenario will mean people taking risk and not getting professional advice. These people could be gambling with their standard of living in retirement and they will have nobody else to blame if it all goes wrong.
The proposed pension changes should be welcomed and many people will benefit from them, particularly those who get the right independent financial advice. However there will undoubtedly be tales of woe from those who make their own decisions, get it wrong and lose out as a result.