In my previous article, I looked at why the money purchase annual allowance (MPAA) was potentially necessary and touched briefly on the pension freedoms and added flexibility.
In this piece, I want to look at how the pension freedoms have allowed greater flexibility for those with modest savings who, pre-April 2015, may have found themselves with a not very sizeable pension.
Prior to April 2015, a pension pot of £30,000 may have provided £1,500 a year or £1,000 if indexed.
Before and after
But let’s think about what choices that gave. If the holder was working and was not in receipt of the state pension the choice was: carry on working; carry on working and take £23 a week after tax from your pension; or carry on working and leave the pension.
After the freedoms all of the original options remain but others come into focus.
You could take the capital and pay off debt; you might be able to retire one or two years prior to state pension; you might be able to defer the state pension for one or two years (government figures suggests this is worth 5.8% a year).
All of these might fundamentally alter retirement in a way that £23 a week might not.
We could look at it another way. Inflation at 2.5% would halve the purchasing power of the £23 a week over 25 years. It would take perhaps 15 years of saving and 5% growth to reach the point where the net value after tax of the fund was recovered.
Pre-freedoms, that was what you had to do with pension income.
Post-freedoms, that purchasing power is available to all at a time to suit their circumstances.
Decisions
I am well aware of the problems of money running out, I am all too clear about the peril of too much choice; I know the worry about people spending money and falling back on the state.
Yet, I’m also keen to give people as much flexibility as possible; to allow people to make adult choices – after all, most people get wiser as they age – and to allow savings to facilitate retirement.
Whatever we do, of course someone may do something daft. This applies equally to the pre- and post-freedom worlds or possibly, more correctly, the worlds before and after drawdown.
What the pre-drawdown world did was to condemn everyone to taking income. This was perhaps fine when people were forced to join employer schemes with a promised benefit but less so when the mortality and investment risk is shifted onto the member.
At that point, it would appear to be natural justice to allow the pension to be taken as capital, income or both.
For the auto-enrolled generation it’s a no-brainer.
For those in pay-as-you-go public sector schemes it is also reasonable to say no transfer (I can justify that position if there’s interest).
The noise comes from funded defined benefit transfers. These are difficult but not that much more difficult than might have been the case if we’d retained capped drawdown.
Freedoms have without doubt given flexibility to the defined contribution generation. That flexibility if used as capital can allow relatively modest pension funds to make a real difference at the point of retirement.
Let’s not forget that when discussing the merits and demerits of the pension freedoms.
Peter Hopkins is director of technical resources at AJ Bell
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