5.4.2 The challenges of the pension revolution

Interesting observation you made, there, about occupational schemes versus private schemes. It seems to me you get a better deal if you're in an occupational pension scheme, as opposed to paying for it all, yourself. Has to be the case, doesn't it. If you're employer is putting in something then it's a better deal for you than actually doing it all yourself through a private pension.

Absolutely, yes. Now employer's, traditionally, provided occupational schemes and particularly if you work in the public sector, local authorities, NHS, emergency services and so on, then you're going to be in a scheme that's called a defined benefits scheme that promises you a certain amount of pension. Although, you're going to be paying in quite high levels of contributions, for that, your employer is paying in even more. The total that goes into providing that pension, for you is probably about 1/5 or 1/4 of your pay but large chunk of that, 2/3 of that is being paid by your employer. Those are pretty generous schemes. What we've seen since 2012 is the rollout of automatic enrolment which means that all employers by 2018 are going to have to provide some kind of pension through the workplace, but most of them are not going to be these defined benefits schemes they are more likely to be the alternative, which is called defined contribution where contributions are paid in and you build up your own pot of savings that you then use at retirement, to provide your pension. Those are far less generous. Under automatic enrolment there are some transitional rules, but once we're past those, the total that will go into that pot is 8% of your own contributions and your employer only has to pay 3%.You pay 4% and then 1% comes from tax relief. A lot of people have said that's well and good; it's a great place to start, but that 8% is not enough for most people to provide the kind of pension that they want in retirement, so, you probably need to look at saving more.

We looked at the first stage which is how much I need in retirement; then the process by which you work back to what pensions provision have I got to do, now, and how I go about it? Let's just say you've now got your pension products running, you're not retired, yet, but then someone tells you or somebody advises you or you make up your own mind that actually you would be better off moving from your current pension products to other pension products which seem to offer a better deal. How easy is it to switch pensions? If I were to move money from one pension into another pension, does the taxman get in the way and take a slice, in the process?

Let's start with that, first. No, when you transfer funds from one pension to another, it's all done behind the scenes and you're still inside that pension wrapper so there shouldn't be any tax to pay. Just a small warning, there, though, there are scams around where people try and persuade you to cash in your pension. Some of these are offshore, and if you do transfer to those, not only do you run the risk of losing all your money but then, your money actually had come out of the pension scheme and you might find that the revenue and customs are after you, for tax, as well, so don't fall for scams and be very, very wary if someone comes to you and says you ought to transfer your pension. It should be a decision that comes from you and you need to think it through. With transfers, there are usually charges.

What sort of level are we talking about?

I can't really answer that. It really depends on the scheme. There are some stakeholder pension schemes that are specifically set up to be portable and can't make a charge for transferring out, but with other schemes, it really depends what kind of scheme you've got. For example, quite a lot of self-invested personal pensions might charge £25 for each holding that you have, within the scheme, so every fund, or every shareholding you have would have a charge, so, it's going to vary, a lot. The advice really has to be, check before you transfer what those charges will be.

Something to really take notice of are the changes coming to the pension scene in the UK. There's a potential for scams to emerge and for people to make imprudent decisions about the movement of their pension money. So, you've really got to keep your eye on the ball, everybody. On a related subject, you may say, ok, I'm happy with my pension arrangements, but what if my pension provider goes bust? Obviously, not in the recent past but several years ago, we did see stories of pensions going bust and pensioners losing their pension income as a consequence. What protection have people got?

You are protected, these days, because of those past scandals. If you're in one of those defined benefits schemes we talked about, where you're promised a certain level of pension, there's a scheme called the pension protection fund so, all schemes, they pay a levee to fund this compensation scheme and if your employer went bust and couldn't pay the promised level of pension, then you would get most of that pension, in some cases all of that pension, up to a certain limit. I think it's somewhere around £32,000 is the maximum that you would get from the compensation scheme. Another type of fraud we saw, way back, was with Maxwell.

Early nineties or late eighties, wasn't it?

Yes. That was when money was just stolen from the pension scheme. There is also another fund called the fraud compensation fund which exists to replace assets that are lost, and provides replacement pensions, up to a certain limit.

Ok. A questionnaire came in from Sue Coddling and Faith Warren and I shall do a name check for people who asked about the ability to swap from one scheme to another. They are: Helen Hemington, Joanne Salters, Carol Rand and Ian Picstone. So, we're moving on now through working life towards retirement. Maybe there's a few decisions people have to make about their pensions arrangements. One question that has come in from Angela Townsend is that you may find when you're approaching retirement that you've got a large number of relatively small pension pots. Does it make sense to consolidate them, and in particular, if you've got some very small pension pots, can you just take all the money out of that without there being a tax liability? I think if it's a very small pot that you've got considerably more ability and flexibility to take some of that money out, haven't you?

You have, yes. As you know, the rules are changing from April, so from April, if you're aged 55 or over, you can take money out of defined contribution pension pots; at any time and in any way you would like, in any case, yes, you can take them as lump sums. There are some other rules at work, at the moment. They will carry on after April, and they apply to all types of pensions, so, defined benefit pension schemes, as well as defined contribution. These are the small pot rules. So, you have to be at least 60 rather than 55 to use the small pot rules. If all your pensions together come to no more than £30,000, or you have individual pots that come to no more than £10,000 you can take the whole of those as lump sums with the caveat that with personal pensions, it's limited to three small pots, in your lifetime. That's to stop people from having a big pot and then just carving them up into lots of little one's and saying, well, I'll just take them all as a lump sum. When you take your money out of these pots as a lump sum the first 25% is tax free and the rest is taxable. Should you combine small pots if you're going to buy a pension income? Usually, you can get a better deal with a bigger pot rather than a little one, so it is a good idea to combine.

OK, so as you're approaching retirement, then, a few decisions about making your overall pot an efficient size and giving you the best value from the money that you've accrued, over your working life and paid into the pension fund. Ok, now you're getting quite close to retirement, now, and you may take the view that for most occupations there is no statutory retirement age, so you'll give it a few more years and defer the pension or delay it, because if you delay it, the annuity you get, the annual income you'll get from your pension pot will surely be more than if I don't delay it. Is that worth looking at, for a lot of people? It seems to be that now, people are working longer and annuities haven't been fantastic in terms of levels, in recent years, because of interest rates. Is this something people should be looking at, closely? Delaying and getting a bigger annuity when you eventually do say, 'I've had enough of work and I am retiring, now'.

Again, thinking about the changes from April, there's a lot more flexibility with pensions, anyway, and I think we're going to see fewer people buying an annuity, even when they do want to start taking an income, they might use a different arrangement. They might leave their pension pot invested and either draw off an income or take out lump sums as they need them. Deferring is usually going to be better, in the sense that, you're then investing your money for longer so it has more time to grow; more time to build up, and it's going to be paid out in a shorter period. If you did buy an annuity, that's reflected in the annuity rate which is then higher, at older ages. With annuities, I would just be slightly cautious because the annuity rate is very highly associated with long term interest rates, which we know are very low, at the moment. Looking to the future, they're more likely to be higher. That would help annuity rates.

But, longevity.

Exactly. They're also associated with the general population living longer. That still seems to be increasing, so that puts a dampening effect on annuities. I think what we might see is a lot of people using their pensions flexibly between their state pension age which is around 65 or 68, depending on when you were born, up to about 85, and then, perhaps, buying an annuity at that age. I think we might see a pattern like that, but it's really too early to say how it's going to pan out, from April, and what new products we're going to see. I don't think we're going to have this bilateral split that we seem to have, at the moment, of either leave your money invested or buy an annuity. I think we will see a lot more products in the middle ground that give you some guarantee's and some flexibility.

Ok, that's a good question that came in from Paul Hogan. When you were talking about annuities, you were referring to new arrangements coming into the UK which kick-in in April which give, people that are looking at their pension pots, greater flexibility in terms of accessing and using those pension pots. An interesting question has come in from Steven Cockcroft. He asks, 'do the pension companies have to comply with these new, flexible arrangements for pensions'. Are there rules that say you, as a pension company, you've got to provide this flexibility, or, is it up to the companies.

It is up to the companies. These are permissive rules in the legislation, but it's up to different providers to decide whether or not to provide all of these options. If they don't, then you would be in the position of needing to transfer your pension, if you wanted to take advantage of the options. I think this is difficult for company schemes. They were never designed to be run like bank accounts. Some of them might not offer the options at all, whereas others, perhaps they will but not be ready for April. All of these pension changes have been rushed in over the space of 13 months. It hasn't given providers a lot of time to adapt and get new systems up and running.

Ok. Two more questions about this pension cycle which we've been talking about in this series of questions. What if I die before I start my retirement and start to receive my pension income? What happens? Was it just a complete waste of money or does someone benefit?

Let's talk again, about April because we're so close now and the rules are changing. If you're under 75, anything you leave in your pension pot, whether it's a pension you've started to draw or not then that can be passed on to tax free to anybody, and it doesn't have to be someone who is dependent, on you. If you're aged 75 or over you can pass it over to anybody, but then it's taxed at the normal tax rates that the person, receiving your tax pot, normally pays, with the exception that just for one year, this 2015/2016 year coming up, if they take it as a lump sum it's taxed at a rate of 45%. Again, that's just a transitional arrangement to give providers time to put new tax arrangements in place.

These new arrangements give much greater flexibility for pensions, effectively, pass on to people who can inherit the money from you.

Absolutely, that's exactly right. They become a tax efficient way of planning for inheritance, which is quite surprising because in the past, we've had a lot of legislation that has been designed to stop you using a pension scheme as a form of inheritance, so, it's a big turnaround.