Exploring the perils of pension freedom

Harvey Jones 30 November -0001

When Chancellor George Osborne gave the over-55s the freedom to control their own pension pots, most were enthusiastic. Who wouldn't want to take charge of their own money? What could possibly go wrong?

Freeing up pensions... 

It certainly seemed more tempting than the alternative, to be forced to buy an underperforming annuity. Especially since annuity rates have tumbled in recent years, so that a £100,000 pension pot would buy a 65-year-old level income of just £5,000 a year.


Cry Freedom

Since pension freedom reforms came into force on 6 April, the over-55s have seized their chance with both hands. They withdrew more than £1.8 billion in the first two months, according to new figures from the Association of British Insurers. More than 65,000 withdrew cash from their pension, taking an average of £15,500 each. Income drawdown has soared in popularity. Annuity sales halved.

All of which is good news, isn't it?


Fear Fraud

Freedom comes at a price, however, and it may be a heavy one. Fraudsters have seized on the reforms to scam older people out of their lifetime savings with too-good-to-be-true investment schemes. Greyfriars Asset Management says thousands are already facing financial ruin after handing their pension to a scammer.

Anyone who feels unsure about a cold call or dodgy pension offer should contact Citizens Advice or Action Fraud on 0300 123 2040.


Tax shock

Many over-55s rushed to withdraw cash from their pension without realising it could trigger a tax charge. That is because any money you take from your pension is added to your income for that year, and taxed accordingly. Many people who have paid basic rate 20% tax during their working life may found themselves paying up to 40% on their pension withdrawals, after taking a large lump sum in one go.

The Treasury is pocketing a tax windfall as a result, to the tune of £700 million, according to advisers Hargreaves Lansdown. Although annuity income is also subject to tax, the bill is often lower because the income is spread over so many years.

Nobody wants to hand 40% of their lifetime savings to the taxman, so plan your pension withdrawals carefully.


Poor law

The final peril may be the greatest of all. The problem is we won't know for many years. It is inevitable that many people will blow their pension pots, then fall back on the State for help. The Government has warned that people who spend their retirement funds or give them away can’t then claim top-up benefits such as pension credit, housing benefit or income support.

The aim is to stop people blowing their pension on holidays or giving it all to their children, then claiming welfare benefits. The ruling may also hit those who run out of money after misjudging how much they need in retirement. Some could spend their final years in severe poverty.

People may be celebrating pension freedom today, but unless they plan carefully, they could be regretting it tomorrow.