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Pension freedoms 5 years on – what the coronavirus crisis teaches us

Five years on since the introduction of pension freedoms, we look at how the coronavirus crisis has influenced pension withdrawals, and why it might prove the freedom naysayers wrong.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Jargon buster

Defined contribution pension: A pension where you pay into a pot and the money can be invested. What you get at retirement depends on how much you’ve saved and how well your investments do.

Pension freedom rules: The rules introduced on 6 April 2015 allowed retirees to take as much out of their defined contribution pensions as they wanted. Before this, most people were restricted as to how much they could take out in one go.

Drawdown: A way that people from age 55 can flexibly access their pensions. For example, drawdown is flexible since you can take out as much as you want. It’s a higher risk option as your income varies depending on the performance of the investments you choose. The first 25% will be tax-free and the rest taxable.

Lump sum payments: A flexible retirement option that lets you reach into your pension and take however much you want as a single cash payment. 25% of the amount will be tax-free and the rest taxable.

Annuity: A retirement option that will pay you a regular income that’s guaranteed for life.

6 April 2015 marked a significant date in the diary as retirees got the freedom to flexibly access their pensions. Before pension freedom rules, most people with a defined contribution pension used their retirement savings to buy a guaranteed income (an annuity) when they retired. Other options weren’t available to everyone.

If you have a defined contribution pension today, things are different. From the age of 55 (rising to 57 in 2028), you normally have the option to keep your pension invested how you choose and withdraw money when you need to. You can even withdraw the whole pension in one go if you want to. Usually up to 25% of the pension is paid free from tax and the rest is taxed as income.

Giving up on secure income brings with it extra risk and responsibility. The fear when these freedoms were introduced was that investors wouldn’t take this seriously and could end up running out of money earlier than planned. But the recent drop in people flexibly accessing their pension might suggest that they’re being more sensible, and perhaps deserve a little more credit.

This article isn’t personal advice. Pension and tax rules can change and any benefits will depend on your circumstances. To find out more about the type of pension you hold and your options, you could get guidance from Pension Wise. Or if you’d like personal advice as you’re unsure on what to do, you could ask for financial advice.

How the freedoms have changed the pension landscape

There’s been a dramatic change in the retirement landscape. We’ve seen a move away from the security of buying an annuity, and a shift towards flexibility and freedom.

In the 2018/19 tax year more than half of retirees with a defined contribution pension chose to withdraw their entire pension in one go. Just over a third opted for flexible drawdown or taking lump sum payments so the rest could stay invested. Just over 1 in 10 chose to buy an annuity (a secure income for life).

Flexible retirement options are a double-edged sword. When you give up secure income, there’s always the risk that you could run out of money before the end of retirement.

If you’re not sure which way to take your pension, you can visit the retirement section of our website to learn more. Pension Wise also offer a free and impartial service to help you understand your options.

Pandemic pressures on pension withdrawals

The pandemic has had a massive impact on global stock markets and this has no doubt reduced the value of a lot of pension funds. By leaving parts of your pension invested, like in a flexible drawdown account, the value can continue to go up and down as the stock market fluctuates.

If you sell when prices are low to generate income, your remaining investments have to work even harder to recoup your losses. Over time, this could erode the value of your pension.

If you’re not retiring just yet and in need of money to see you through recent events, you could think about taking money from other savings, and avoid dipping into your pension.

Showing restraint in tough times

We usually see an increase in the number of people flexibly accessing their pension after April as personal tax allowances are reset. But figures from HMRC show that people might be rethinking accessing their pension in light of the crisis.

Over the last 3 months savers have reduced their withdrawals. We’ve seen the total amount withdrawn drop by 17% compared to the same period a year ago.

The chart below shows that pay-outs are now the lowest per person since 2016. People are likely to be thinking long-term and acknowledging that taking money from their pension when prices are lower could mean they run out of money sooner.

We think this is the approach savers should be thinking about. Using emergency cash reserves instead of your pension in tough times gives your investments more time to recover. Although there’s no guarantee that investments will go up in the future.

Flexible Pension Withdrawal Sizes

Scroll across to see the full chart.

Source: HMRC.

Pension planning during turbulent times

Back in 2015, the hubbub was that investors would start shovelling money out of their pension and not think about the consequences. But the reaction to the COVID crisis suggests that lots of people understand the associated risks. Investors are taking more responsibility for their retirement and thinking ahead to the future.

However, it’s one thing to choose a flexible retirement option knowing the risks, and it’s another to experience them first hand. The recent stock market dip would’ve shaken the confidence of lots of pension investors.

If you’re thinking about taking money from your pension, it’s important you get the full picture first. Read our guide to find out about the benefits and risks of each option.

How to take money from your pension

What you do with your pension is an important decision. You should understand all of your options and know that the option you choose is right for your circumstances. If you’re unsure, you should ask for financial advice.

If you’re already in drawdown, now could be a good time to have a think about where you’re invested and how much income you’re taking. Check out our guide for three drawdown investment strategies and fund ideas.

Guide to investing in drawdown

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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