Be careful with your pensions freedom

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Leap free, but take precautions

Savers are using the pensions freedom rules to dip into their retirement funds at an alarming rate, says David Prosser.

The average amount that savers with income-drawdown plans withdrew from their pensions rose sharply last year, prompting new concerns that people could run out of money in retirement. The average saver with an income-drawdown plan took out 5.9% of their pension fund during the 2017-2018 financial year, up from 4.7% in the previous 12 months, says the Financial Conduct Authority (FCA), the City regulator.

The numbers are worrying because financial advisers have repeatedly warned that people taking advantage of the pensions-freedom reforms of 2015 could end up jeopardising their financial security later in life. The reforms have made it much simpler to withdraw income directly from a pension fund in retirement, rather than using the fund to buy an annuity contract from an insurer. But people who choose this route must make sure they manage their withdrawals with care, so their pension funds don’t run out too soon. This requires discipline about how much is taken out each year, as well as careful ongoing investment of the remainder.

Note that the regulator’s data do not provide a full picture, as they do not include statistics on how many people making withdrawals actually have other savings to fall back on. Some people may consciously be withdrawing large sums from one pension scheme in the knowledge they have another scheme where they have yet to begin drawing benefits, or they may have other forms of savings.

Make it last

However, the FCA has repeatedly said it is worried many people don’t have a good understanding of how to manage their savings to ensure they have enough money to last for their whole retirement. The regulator’s research suggests that a third of those going into income drawdown, once considered a complex product suitable only for wealthy and sophisticated savers, don’t take independent financial advice before setting up their plans.

In practice, the amount it’s possible to withdraw from a pension fund without running it down to zero too quickly will depend on the investment returns the remaining savings generate over time. But given that returns are not guaranteed – and no one knows how long their retirement will last – it’s best to be cautious. Many believe that savers withdrawing more than 4% of the fund every year can’t be confident that their money will outlive them. If investment returns disappoint in the years ahead, or savers have chosen to invest in low-risk assets such as cash, that figure could be even lower.