Retirees could be overpaying tax, missing out on investment growth or losing other valuable pension benefits by taking all of their money out of their pension and moving it to a savings account, while others are potentially getting a poor pension deal by not shopping around, a new review of the retirement market has found.
The Financial Conduct Authority (FCA) has carried out the most in-depth study of the pension freedoms to date. The pension freedoms were introduced in April 2015, giving pension savers the option to take all of their money out of their pension pot in one go, should they wish.
The report has uncovered the huge popularity of the pension freedoms, and that three quarters of people who have accessed their savings using them have done so before the age of 65, the typical retirement age. It found that:
- 1 million pensions have been accessed under the freedoms
- 72% of pots have been accessed by under 65s
- 53% of pots accessed were fully withdrawn
- 90% of fully withdrawn pots were smaller than £30,000
- Twice as many pots move into drawdown than annuities – before the freedoms were introduced, 90% of pension pots moved into annuities.
The good news is that the FCA found no evidence of people ‘squandering’ their retirement savings – a big fear that emerged when the pension freedoms were announced. Almost all people who’ve taken all of their money out in one go had other of income, such as a final salary pension or the state pension, to rely on.
Pension freedom problems exposed
That said, the watchdog has identified five big problems with the retirement market, and has proposed a series of changes to improve it and help retirees get the best deal.
1. Pension savings are being placed into poor-paying cash savings
The financial watchdog found that more than half of the pensions that had been withdrawn in full – meaning people had emptied their pension pots and taken it all in cash – were moved into other savings and investment products.
A third of people put their money in a savings or current account. The FCA warned that this could come with a number of risks, including:
- earning inferior interest rates – currently no savings account can beat inflation
- potentially encountering large income tax bills for cashing in their pensions. Which? has found that many people could also be overpaying tax on their pension and failing to reclaim the money
- losing out on valuable benefits from their existing pension, such as guaranteed annuity rates, which are often far higher than standard annuity rates.
This comes down to mistrust in the pensions industry, and negative coverage of a variety of pension issues in the media.
2. Retirees aren’t shopping around for drawdown plans
The FCA found that if people access their money earlier than their retirement age, they tend to take the plan offered by their pension company. The regulator says that they could end up paying higher charges as a result, as there is little competitive pressure.
It wants to change the way that the process works when people take tax-free cash from their pension. Currently, when you take your 25% tax-free lump sum, you have to either move your money into a drawdown plan or buy an annuity. The FCA wants to ‘decouple’ this, so that you can take a lump sum but don’t have to choose a financial product for the remainder of your savings.
This doesn’t affect people who access their money by taking an ‘uncrystallised pension fund lump sum’ – where the first 25% of your withdrawal is paid tax-free and the remainder is subject to income tax.
It also wants to help people to shop around, perhaps by introducing comparison tables for drawdown products.
3. The FCA is worried that people choose drawdown without advice
According to the FCA’s report, 5% of drawdown was bought without advice before the freedoms were introduced, compared to 30% now. The FCA says that ‘drawdown is complex and these consumers may need more support and protection.’
This could include developing ‘default’ investments, which means that retirees are offered investments based on what they want from their retirement savings, and a cap on charges on default investments to prevent them being overcharged.
4. The annuity market is getting smaller
Despite the soaring popularity of drawdown under the freedoms, annuities can still be a good option for people. They provide a guaranteed income for life, although rates have been falling due to low interest rates and growing life expectancy.
However, the FCA found that many annuity providers are leaving the market, giving retirees less choice and a poorer range of products to choose from. One thing it wants to do is boost awareness of enhanced annuities, which pay a higher income if you’re in poor health. In a 2014 study, the FCA found that people could increase their annual income, on average, by £135 by taking an enhanced annuity.
5. New, better products aren’t being launched
While there are better tools to help people invest in a drawdown plan, and some of the drawdown products have been simplified, the FCA is worried that the private sector hasn’t done much in terms of innovating and launching new retirement products. It wants to see options that give people the flexibility of taking their money as they wish but also offering some kind of guaranteed income.
Where can I find out more about planning my retirement?
Which? has published a whole host of free tools and guides for you to use when you are planning your retirement – from finding out how much income is enough to have a comfortable life, to using drawdown and the tax bills you could face taking your money under the pension freedoms.
- How much will I need to retire? – find out where retirees spend their money
- Options for cashing in your pension – all the opportunities available to you
- Pension tax calculator – how much you’ll pay when taking a lump sum
- Income drawdown explained – including our calculator that shows when your pension might run out
Which? reaction to the FCA’s findings
Gareth Shaw, Which? money expert, said: ‘Deciding how to turn your hard earned pension savings into a retirement income is one of the most daunting and complex decisions people have to make.
‘Consumers deserve to get products and services that help them make the most of their savings in retirement, so it is worrying that the FCA has highlighted that many people are not shopping around or taking much needed advice.
‘The annuity market failed pensioners in the past. The FCA must now use this review to ensure that similar mistakes are not made with income drawdown products.’