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Decade of pension liberties scrutiny: what choices have retirement investors opted for?

Beginning in April 2015, retirees gained the ability to withdraw funds directly from their pensions without first purchasing an annuity. This analysis examines the repercussions of pension freedoms and the ways in which spenders have utilized their funds.

Starting in April 2015, pension holders reached the age of withdrawal have been authorized to...
Starting in April 2015, pension holders reached the age of withdrawal have been authorized to withdraw funds directly. This article examines the aftermath of pension freedoms and details how retirees have used the funds.

Decade of pension liberties scrutiny: what choices have retirement investors opted for?

Over a decade ago, pension savers in the UK were given a new freedom: to withdraw cash from their pension pots at age 55 however they preferred. This marked a significant shift from the requirement to buy an annuity, allowing them to spend their retirement savings on whatever they desired, even splurging on a fancy car, as then pensions minister Steve Webb humorously hinted. Dubbed "pension freedoms", these new rules took effect on April 6, 2015, leading to a significant drop in annuity sales.

Most savers quickly took advantage of the newfound freedoms, opting for income drawdown, which allows for flexible access to funds. Rachel Vahey, head of public policy at the investment platform AJ Bell, called the rules "the biggest pensions shake-up in a generation". As we celebrate the 10th anniversary of pension freedoms next month, let's explore how savers have used these newfound freedoms, the choices they've made, and what they've spent their nest eggs on.

According to a poll on our website, more than a third of people would sensibly utilize their retirement savings for home improvements or to help family members, while only 5% would spend it on a fancy car.

How have savers accessed their pension pots?

Seven million pension pots have been accessed for the first time since April 2015. Before the pension freedoms, about 75% of defined contribution (DC) pension schemes were used to buy an annuity. However, that has plummeted to less than 10% currently as annuities rapidly fell out of favor. Drawdown is the most popular option for people accessing pots of £30,000 or more, with approximately 60% opting for it last year.

However, annuities have shown signs of a comeback due to higher interest rates and gilt yields in recent years. Annuity sales increased by 24% last year, according to the Association of British Insurers.

For those opting for drawdown, a key retirement question to consider is how much money to withdraw. While you could spend some of your life savings on a luxury holiday at the start of retirement, managing the rest of your pension to last as long as you do becomes crucial.

AJ Bell found that withdrawing a pension income of 8% or more each year is common—but this also reflects the large number of smaller pots depleted quickly. Among those with £100,000 or more in their pension pot, 65% withdrew less than 6% income last year, with 44% taking less than 4%, according to AJ Bell.

A sustainable withdrawal percentage, such as the 4% pension rule, can help ensure savers avoid running out of money during retirement. Many savers with small pension pots of less than £30,000 chose to withdraw the entire amount all at once. Presumably, they have other pensions, such as a defined benefit pension and the state pension, which will continue to provide an income until they pass away.

Spending the tax-free lump sum

Despite initial fears that the government might scrap or reduce the 25% tax-free lump sum, it remains an essential feature of the retirement savings landscape. More than half (55%) of those eligible to take a tax-free lump sum chose to take the maximum 25% of their pension, according to Royal London. Nearly a third (32%) of those who took out a tax-free cash lump sum used it to pay off a mortgage or other debt, while about 1 in 5 (19%) spent it on home improvements and 1 in 12 (8%) gave it to family members.

Clare Moffat, Royal London's pensions and tax expert, notes: "Pension freedoms were designed to give consumers more flexibility and choice about their retirement, and they've certainly done that. Despite comments at the time that people could buy a Lamborghini with their retirement pot if they so wished, we've found little evidence of people doing so."

While withdrawing the tax-free cash and putting it into a savings account may seem like a smart decision, it's important to remember that any interest earned on those savings is liable for income tax. One way around this is to use a cash ISA, which is tax-free, or to leave the money in the pension and only withdraw it when you're about to spend it.

The risk of making a bad decision

Choosing how to access your pension pot is a significant decision. These are your life savings, designed to fund your retirement, which could last anywhere between 20 and 30 years. The arrival of the pension freedom rules has added another layer of complexity.

There is also the question of tax: while a quarter of each pension pot is tax-free, the rest is subject to tax. Some pension savers pay for financial advice or receive guidance from the free government-backed service Pension Wise to help manage their nest eggs. However, according to Royal London, almost one in five (18%) of those eligible to make a pension withdrawal had not taken any advice at all before taking money out of their pension. Only 20% of consumers aged 50 or over with a workplace or personal pension used Pension Wise. And only 4 in 10 looked at the tax implications of withdrawing a taxable lump sum from their pension.

Moffat notes: "The pension freedom changes have left consumers making difficult decisions that could affect their standard of living for many years to come. It is concerning that so few people took financial advice or made use of free guidance services, such as Pension Wise. Worryingly, our research shows that many made decisions that may not have been in their best interests over the longer term. We would encourage people facing complex financial decisions to take advice from a financial adviser—it could be time, and money, well spent."

Overall, the majority of savers who have accessed their retirement savings since the pension freedoms were introduced say they have benefited from the increased flexibility. However, some express concerns about making suboptimal financial decisions and outliving their savings. If you value peace of mind and security above flexibility, an annuity could be the best choice for you. You don't have to take advantage of the pension freedoms if you don't want to. Bear in mind that for some people, a "mix and match" approach might be the best option, withdrawing the tax-free cash and perhaps some additional funds to tackle essentials and a few luxuries at the start of retirement, while holding the rest of the pension pot to buy an annuity later in retirement.

  1. Many retirees are accessing their pension pots through income drawdown, with about 60% opting for this method when their pots are £30,000 or more.
  2. Among those who take out a tax-free cash lump sum, around one-third use it to pay off a mortgage or other debt, while about 19% spend it on home improvements and 8% give it to family members.

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