Pension freedom pitfalls

No fast cars
August 20, 2018

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The pensions transfer tsunami powers ahead. Savers moved £11bn in the first quarter of this year to new pension schemes, the largest quarterly total since the government gave all over-55s the freedom to withdraw their pension savings and do what they like with them.

The former pensions minister, Steve Webb, grabbed much attention for suggesting some might choose to blow it on a Lamborghini. But there are taxes to pay if you really were to blow the lot, and in practice most of the cash is moving from gold-plated final salary pension schemes into individual pension pots holding bonds and shares. These offer no guarantees about future income and are vulnerable to crashes.

With “drawdown” pensions, instead of buying a fixed annual income which vanishes when you die, you keep the funds inside a tax-privileged wrapper after you retire and access them as required. Compared with an annuity, you gain control of your money and anything left over can be passed on. But again, the new freedom comes with risks. In a crash, your nest egg can vanish, if you live “too long” or withdraw too fast you can run out of money.

In this world of freedom and insecurity, one of the few certainties is that is that it pays to keep a close eye on fees. While you are paying in, managers’ charges are capped at 0.75 per cent of the fund’s total value. Since the fund tends to grow as people save, this suits managers well: their fees grow in proportion.

But when people retire, there is no cap on charges and their fund will gradually shrink—a headache for the managers since their fees will do the same. This is why average drawdown fees are higher than when you’re paying in. But higher fees on a shrinking pension is a terrible deal. Pension freedoms sound attractive, but that freedom comes with risk—your pension pot might just spring a leak.

Read Diane Coyle on markets vs property