Articles - The real risks of freedoms

When pension freedoms first came into play there was no doubt that while they offered welcome flexibility, they also resulted in more risks that could severely impact on savers. In the four years since then we have found that, while the key risks were largely as predicted, the prevalence and resulting impact were not.

 Fiona Tait, Technical Director, Intelligent Pensions
 1. The Lamborghini Effect
 Incidence: Low
 Impact: High
 At the top of the list at the time of pension freedoms, was the idea that people might simply cash in their pensions and use them to gratify short terms needs, such as the famous luxury car. Experience to date suggests however that this concern has been largely unsubstantiated.
 While 53% of people accessing their pension have taken it in full, 90% of these are very small pots which may not have been sufficient to provide a meaningful life time income in any case. Rare cases, such as the man who withdrew £120K from his pension and immediately gambled it all away, show that the impact would still be extremely high but the incidence is however thankfully low.
 2. Emergency tax on lump sum withdrawals
 Incidence: higher than expected
 Impact: high short-term impact
 Given that pension freedoms came as a surprise to all, it is not surprising that HMRC announced that full pot encashments would be subject to emergency income tax, this being the existing methodology for income withdrawals. That this is still applicable nearly 4 years later is considerably less acceptable, and the cynics among us will certainly wonder if the £400m collected and repaid by HMRC under this method is a factor.
 Although any overpaid tax will eventually be returned via adjustments to PAYE, the short-term affect is extremely high, particularly for those who did not expect it.
 3. Cash Investing
 Incidence: higher than expected
 Impact: high long-term impact
 Around a third (32%) of individuals who have cashed in their pension fund go on to invest it in cash via a bank or building society account. Not only are they giving up the tax-advantaged status of the pension wrapper and paying tax to do so, they are also limiting the potential for future long-term growth.
 A second group are marginally savvier in that they are only withdrawing tax-free cash, and thus avoiding the tax penalty, however the remainder of their fund is invested in cash as they don’t know what else to do with it and it is perceived to be low risk.
 Helping people to invest their residual pension after withdrawals have been made is a priority for the FCA, resulting in their proposing a number of investment pathways which are designed to address this.
 4. The retirement mindset
 Incidence: very high
 Impact: potentially very high long-term impact
 This has yet to receive a lot of attention but if the trend is not addressed the impact on people’s future retirement could be extremely high. Traditionally people accessed their pensions at the point of retirement, and naturally switched from savings to spending mode. Since pension freedoms were introduced, 40% of those accessing their retirement pots are in their 50s and may still be working.
 Despite this the vast majority who have taken a uncrystallised funds pension lump sum (UFPLS) or gone into drawdown do not contribute any further to their plan.
 It is of course possible that they have other pensions or non-pensions savings elsewhere –but the fact remains that these individuals have just depleted their retirement funds and should probably be building them back up again.
 5. Sustainability
 Incidence: unknown
 Impact: high long-term
 The FCA and its predecessors have long been aware of this issue, but it was exacerbated by the removal of all income limits on drawdown under the pension freedoms. For a number of reasons most people underestimate how long they will need their retirement income to last and could find themselves running out of funds in their later years.
 This is a problem that may not manifest itself for a number of years, but current figures suggest that many people are making withdrawals in excess of the likely sustainable rate..
 6. Scams
 Incidence: still high
 Impact: potentially 100% of savings
 This is in my view by far the biggest danger – not least because the impact could be total. Some people are being seduced into unsuitable investments which fail to deliver the promised returns, others have invested in non-existent or fraudulent schemes where the whole of their fund could be lost.
 Banning cold calls and the introduction of project ScamSmart are helping to address this issue but we cannot afford to relax our guard in any way.

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