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When we withdraw money, are we using it sensibly?

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It’s almost 1,000 days since the pension freedoms were introduced in April 2015. That’s given us plenty of time to look at how people have made use of the new options the freedoms have introduced – and enabled us to answer some important questions.

As a quick reminder, Aviva has produced a short video to remind you of the new pension options.

 

When the freedoms were introduced, some suggested that they would lead to irresponsible spending, with people using hard-saved money for short-term treats. But has this really been the case?

 

In July, a major review of the pension freedoms was published. It stated that over half (53%) of pots accessed have been withdrawn fully[1]. The report identifies what these people have done with their money:

  • 52% of the money withdrawn has been saved or invested
  • 25% has been spent
  • 14% has been used to pay off debts
  • 9% is unknown 

If we choose to fully withdraw our money, what should we be considering?

  • Consider your life expectancy: pension savings are primarily designed to fund an income in retirement. This raises the question of how long we may live. Life expectancy has been on an upward trend for much of the past century – to such an extent that we often underestimate how long we may live, and therefore underestimate how long our money may need to last. Aviva provides a free life expectancy calculator to give you some understanding of your potential life expectancy.

  • Consider your other sources of retirement income: before you access your private savings, it would be wise to fully understand what other sources of retirement income you have. The research found that the vast majority of people withdrawing their money had other sources of retirement income. Only 6% had no other sources of retirement income beyond the state pension[2]. This is encouraging as it suggests people aren’t taking all their sources of money in one go. Once all your money has gone, it has gone.

  • Consider the value of the state pension: one in five (21%) reported that their most significant source of income in retirement would be the state pension. The British state pension is one of the oldest in the world, yet over the years it has become one of the most complicated. For many people it would make sense to be sure of your state pension entitlement, and the age at which you are scheduled to receive it. Unlike private pensions, the state pension cannot be accessed early. The government provide a free service to request a state pension forecast.

  • Consider tax: the new rules give us much greater freedom as to when and how we can access our pension savings. But, in many circumstances, they do not free us from the responsibility to pay tax. When you withdraw your money, the amount you withdraw can have implications for the amount of tax you pay. Our article If you’re considering taking all your pension as a cash lump sum discusses this in detail.

You may have saved for forty years before choosing to access your money. Take more than 40 minutes in deciding what to do with it next.

Consider the charges, risks and returns on new savings or investments: more than half (52%) of the money withdrawn has been saved or invested elsewhere. There may be very good reasons for this – such as securing easier short-term access to the money – but consideration should be given to the new home into which you may choose to put your money. For example, how do the new charges compare with your pension charges? Charges can have a significant impact on the growth of your money. Also, how much risk will you be taking on by moving your money to its new home? For example, some may be tempted to invest pension money in property. This could be attractive, but it comes with the risk of placing ‘all your eggs in one basket’. In a pension, we typically spread our money across various investment funds to help ride the ups and downs of investment prices. And what returns will you receive? Pensions benefit from tax-free investment growth, and if you are in a workplace pension you will likely benefit from an employer contribution too. These benefits may not exist in your money’s new home.

Consider any guarantees you may be giving up: some pension products come with what is known as a ‘guaranteed annuity rate’ (GAR). These GARs often enable the saver to purchase an annuity – or guaranteed retirement income for life – at a rate above that available in the open market. The research reports that 57% of customers with GARs gave them up by accessing the freedoms[3]. Most (51%) people doing this did so with a pension pot worth less than £10,000[4]. So, they may have concluded that the guaranteed income provided by the GAR wasn’t enough to deter them from using the freedoms. Regardless, it’s important to consider what guarantees you could be giving up when withdrawing your money.

Consider shopping around: you may have saved with your pension provider for many years, but there’s no need to stay with that provider when you withdraw your money. The report found that “most” consumers were taking the “path of least resistance” when withdrawing their money[5]. This may be the right decision, but you could possibly secure better value by considering different providers for different options at the point of withdrawal.  

AR011017 08/2017

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