New pension rules explained take the whole lot as a lump sum

0117 980 9926 www.hl.co.uk October 2014 New pension rules explained take the whole lot as a lump sum On 19 March the Chancellor announced what he described as the most radical changes to pensions in almost a century. It wasn t an exaggeration. For the first time ever pension investors can decide how to take money from their pension. From April 2015 all income limits and restrictions will go. Providing you are 55 you could even take the whole of your pension as cash if you want. So what could the changes mean for you? How will they work in practice and will everybody benefit automatically or could you miss out? To find out more we ve asked Tom McPhail, Hargreaves Lansdown s Head of Pensions Research. Charlotte Cowen: So, Tom, what is all the fuss about? Tom McPhail: Well, the Chancellor described this as the biggest change to pensions for a hundred years and for once the reality justifies that kind of hype. The government has fundamentally changed the relationship between the state and individuals on retirement savings and it really will make a difference to 18 million people. The government said: you can do what you like with your retirement savings pots. We are going to step back, we are not going to interfere. It s your money, you do what you like with it. This is really pretty radical stuff. Charlotte Cowen: So the new pension freedoms is the real game changer, isn t it? Can we discuss that in a little bit more detail? Tom McPhail: OK, so let s start by just breaking down exactly what has changed. First of all, let s look at how it works today: you put some money into a pension pot and your employer might add some money as well. Hopefully over time the money will grow. Then typically when you get to retirement in most cases you hand the money over to an insurance company: you buy what is called an annuity and in return you get a guaranteed income for life. Now, you have got a great deal» IMPORTANT NOTES It is normally only possible to access money in a pension from age 55. Taking money out of a pension will impact standards of living in retirement. Before transferring a pension you should check you will not lose valuable benefits or guarantees or incur excessive exit fees. A SIPP (Self Invested Personal Pension) is for people happy to make their own investment decisions. The value of investments can fall as well as rise so you may get back less than you invest. Tax treatment can change and depends on your circumstances. This information, like our service, is not personal advice. If you are unsure an investment is right for you, contact us for advice. This video is based on our current interpretation of the (Draft) Taxation of Pensions Bill published on 6 August 2014. It is a broad summary and cannot cover every nuance. You should not take, or refrain from taking, any action based solely on this video. Source for performance figures quoted: Lipper (ABI UK - Mixed Investment 40%-85% Shares-Pen; FTSE All-Share TR; Invesco Perpetual High Income Inc 01/08/1994-01/08/2014). ipad is a trademark of Apple Inc. One College Square South, Anchor Road, Bristol, BS1 5HL www.hl.co.uk 1

of security with that, it s a guaranteed income, but you have completely lost control over your money. Charlotte Cowen: So, that s how it was. What part of that is changing? Tom McPhail: The big change from next April is that as at present you will still be able to buy an annuity if you want, but if you don t want you will be able to take as much money out of your pension pot as you like. So, once you reach the age of 55, you will be free, if you want, to take all of your money out in one go and the government says they are quite relaxed about that, you can do that. Now, this is a massively radical change of attitude on the part of the government, to just hand this responsibility back to people and say do what you like. Charlotte Cowen: Wow, that certainly sounds incredibly exciting and a real shift change. So are there really no limits and no restrictions at all? Tom McPhail: The key restriction is that you have to be 55 to take advantage of this. But after that there really is almost no limit. You can take a quarter of your money as a tax-free lump sum and after that if you want to take it all out in one go, you can. And if you want to just dip into your pension pot as you go along, perhaps take a little bit of income from time to time or periodic lump sums, that s up to you. It s your money, you do what you like with it. Charlotte Cowen: So, it is indeed very exciting, but it seems to come with quite a lot of responsibility at the same time. What sort of things should an individual be considering before they make these decisions? Tom McPhail: That s absolutely right and I think with these freedoms come responsibilities. So, it s very important that people first of all think about how much secure income they might need in retirement. For some people the investment risks and the flexibility might be inappropriate; it might be safer and simpler just to buy an annuity with all of their pension pot. So, for some people that will be still the right answer. Then you might want to consider if you are going to keep some of that money flexible: how much, how you want to balance off the two, how much you want to allocate to an annuity, how much you want to keep invested flexibly. Then decide what you are going to do with that money: how much you are going to draw, how and when you are going to tap into that money, and, of course, crucially you also need to think about the tax implications because if you take money out of your pension pot, particularly if you take out big lump sums, you will be liable to tax on it and in some cases it could be a very substantial amount of tax, so you need to plan carefully. Charlotte Cowen: Yes, tax is something that often worries people. So can we perhaps look at someone who wants to take some money from their pension pot: how much tax would they pay in a specific example? Tom McPhail: So, let s look at someone who is age 60, who s done well with their pension, let s say they have got a quarter of a million pounds. Well, the first thing they could do is take out a tax-free lump sum, so they would be allowed to take up to 62,500 out as a tax-free lump sum, as they can at the moment. Then, they can leave the rest of the money invested. Charlotte Cowen: Let s look at the other end of the scale, perhaps someone who is not lucky enough to have a pension pot worth that much money. How much tax would you pay on a smaller pot? Tom McPhail: So, let s say you have only got 30,000 in your pension pot which might be more relevant for more people. Even with that you would get a quarter of it tax free so that would be 7,500. If you took the remaining 22,500 out, particularly if you had some other sources of income such as the state pension, you would probably still find yourself paying perhaps a few thousand pounds in tax on that lump sum. So, even for people with small pots that tax consideration is very important. Charlotte Cowen: There seems to be an awful lot to think about and April 2015 really seems just around the corner. So, in terms of who it is going to affect the most, is it people who actually are quite close to retirement? Tom McPhail: Well, it is certainly relevant to people who are close to retirement. They are the ones who are going to be able to take advantage of these freedoms first. But, of course, it also affects people who are further away from retirement, because they have got more time to kick their retirement plans into shape and ultimately may well be able to take greater advantage of these new freedoms. So, it really does affect those 18 million people that the Chancellor talked about in his Budget speech. Charlotte Cowen: So, it sounds very much like different groups of people are going to be affected, but all in slightly different ways. So perhaps we could look at different groups? Initially, people who are planning to retire in a fairly short timeframe: if they retired before April, could they potentially miss out on all these changes? Tom McPhail: No, they could still be able to take advantage of these new freedoms. For example, if they need some money now, they could use the current drawdown rules to take some money out of their pension pot: they could access their tax-free lump sum, they could take some income out of their pension pot but currently subject to restrictions. Then, from next April they will be able to use new freedoms in their entirety, so they would at that point be able to take the rest of their money out of the pension pot if they want to. So, they do have the freedom just to say look, I don t need any money now, I am just going to wait until next April and at that point I will be able to tap into the new rules. But if they need some money in the interim, they can get at some of their pension pot and then still use the new freedoms from next April. Charlotte Cowen: That certainly makes sense. So people aren t going to miss out: they could start now and then get greater freedom after April. Indeed, many Hargreaves Lansdown clients have been starting to think along those lines and starting to already do that. We interviewed one such client who is happy to tell us about their story. If we assume they had no other income, they could take 10,000 out and that would be covered entirely by their personal allowance so they would pay no tax on that 10,000. If they took 20,000 out, they would end up paying 2,000 in tax on that lump sum. If they took 50,000 out, it gets a little more awkward and they would end up paying around 9,000 in tax on that 50,000 lump sum. And if in the extreme example they took the whole 250,000 out as a single payment, which they would be entitled to do, they would get a quarter of that tax free but they would then end up paying around 70,000 in tax. So, they would only actually get into their bank account around 180,000. 2

Lillian Billing, London It has been interesting looking at media reports seeing that people are already embracing these new freedoms and are putting more money into their pensions. Just with Hargreaves Lansdown we have seen over an extra 100 million paid into pension pots as a result of these reforms. So, clearly, the message is getting out there. Charlotte Cowen: Absolutely. Investors are far more enthusiastic about pensions than they have been in a good number of years, which is fantastic. We have interviewed one of the Hargreaves Lansdown clients who has decided to increase their pension contributions in light of the pension freedom changes, so we are going to hear their story. After correspondence from my paid up pension, I received that letter that says you are approaching the age where you are eligible to withdraw your pension. That s quite a shock, but it happens, we all get there at some point. I decided to defer it for 5 years and then I thought to myself: well, here is this sum of money, sitting there, what can I do with it? My pension provider who had gathered together all these disparate pieces of pension planning that I had, was willing to pay me that proportion which was tax-free cash, but at the same time they also wanted me to commit the rest to an income. It was either all or nothing. Then a friend who had recently retired from financial services said: why don t you get in touch with Hargreaves Lansdown? I think they might be able to help. They are just wheeling out a facility, whereby you can transfer your money out, take that proportion which is tax free, which is the element that I wanted now, and they will hold over the balance to meet the promise of new legislation that s out next year. Then you can decide whether to take more cash, which of course would be taxed, or defer it into other investments. This seemed to make more sense to me and suddenly gave me options that were attractive. They were options that met my plans not the convenience of someone else s legislation or a company s own internal policies. I was delighted to be able to do that. You think of anything to do with pension planning and pension bureaucracy as taking an age, but once the process started, wow, it was really quick. The follow through was great: I was informed regularly of what was happening. This morning, I had a lovely piece of news. My mobile phone pinged: there was a text message from my bank; I looked at my balance and I was delighted to see that my tax-free cash had appeared on my current account. This was quick and very good timing because I know exactly what I am going to do with it. It has been a very easy, simple, straightforward process without any hiccups or problems and I am delighted. Charlotte Cowen: So, that s what you could do if you are 55 or older and are planning to retire fairly soon. But what about if you have got 10, 20 or even 30 years to go? Do these changes affect those people yet? Tom McPhail: Yes, absolutely, they do really affect everybody. Of course, people who are that little bit further away from retirement have more opportunity to change direction and the eventual outcomes, because they have got more time to change their pension plans. So I would say that people who are 20 or 30 years away from retirement will ultimately be able to take even greater benefit from these reforms. Of course, the critical thing with these reforms is the amount you get out of your pension at the other end is dependent first and foremost on how much you have paid in. If you don t pay enough into your pension pot, ultimately almost whatever else you do, you are unlikely to get a decent return at the other end. Phil Warren, Burnham-on-Sea In my earlier years I was incredibly sensible: as I progressed through my career if I found myself with a little bit of extra money, I would try and put it in my pension. Then during the middle part of my career, I kind of neglected my pension: as life changes, priorities change. My children were the focus of my attention and my pension was one of those things that I just put to one side; it wasn t something I was incredibly focused on. The children have grown up now and my pension is one of the things I have actually more of an active interest in. It is something I feel like I am in control of now, something I have got back. I am more comfortable with the position I am in now than I have felt in a long time. I think the Budget changes have reinforced my focus with regard to my pension. I am 44 now, amd a pension is actually something that s real now. When you re younger, it s something in the never-never, it means nothing. But now I am actively thinking: when am I going to retire? Is it in 11 years when I am 55? I would like that to be the case, but I can t imagine that I will be at that stage but it s an option. Some things never change and I guess once you re a parent your children are always in some ways the focus, and they certainly are for me. A pension is not just thinking about myself, it s thinking about where my children are going to be in 10-15 years. They will have got careers of their own, perhaps even starting out in their own business, and perhaps they need money. I think my pension could be the best way for me to help them out. As someone who is self-employed, it is difficult to make a commitment to a regular set amount. When I am in a position to make contributions, it s easy to do: just log on and do it by a debit card payment, as simple as that. Charlotte Cowen: So, you could consider topping up your pension. But is there anything else you can do to try and boost the pot? 3

Tom McPhail: Well, the other critical thing is just to review your pension regularly, not just to set it up and then walk away and forget it. Even once a year is note quite enough. It s good to review your pension regularly. Charlotte Cowen: Is there a set amount of time? How regularly? Tom McPhail: I think you need to work with what works best for you. I think a critical thing here is: it s much, much easier to do if you have got online access to your pension account, or, better still, if you use a smart device, an app, so you can check on your pension on your phone or your ipad. That makes it a great deal easier. Barry Moorhouse, Castle Cary Charlotte Cowen: So what factors should people be considering when looking at their investments? Tom McPhail: Well there are a couple of things to consider. First of all you need to select investments that will match your risk profile and that will maximise your returns without doing anything reckless that you would be uncomfortable with. I think it s also important to look at the default funds because we know most pension investors simply go into the default fund and they just stay there. That too is something that s worth reconsidering, because for most people the default fund may not be appropriate. We looked at some of the investment return numbers on default funds. Across the whole pension industry the typical default fund, that someone would get put into when they go into a workplace pension, has returned an average of 6.2% a year over the last 20 years. If someone had 10,000 invested in one of these funds, over 20 years it would have grown to over 33,000. Charlotte Cowen: Well that sounds quite good. How does that compare? Tom McPhail: If you look at what the stock market would have returned over the same period, if you had just been able to replicate exactly what the stock market would have delivered, then you would have got a 7.8% return. That would have boosted your pay out to around 44,500. What s really interesting is, if you then compare that with what we found to be the most popular fund that our clients have invested in on our Vantage platform through their SIPPs (Self Invested Personal Pension), that would have produced an annual return of 11.8%. It would have turned that 10,000 into over 92,000 over the same period. The important thing to bear in mind is that past performance is no guide to the future. These are past performance figures and individual investments will produce individual returns: they can fall as well as rise. Charlotte Cowen: So, how do you go about selecting your investments? Tom McPhail: What you need to do there is to do your own research. You need to look at what the pension schemes make available to you, what information they can offer to help you with that. Good pensions will make that easy for you: they will produce research and guidance to help you with that. If you find that your pension doesn t offer the information or the investment choice that will meet your requirements, that s when perhaps you should consider switching. Of course, the great advantage of a SIPP, for example, is that it offers a complete range of investment choices. Charlotte Cowen: In fact many people have been switching to the SIPP for that very reason. We have spoken to one of Hargreaves Lansdown s clients who has actually made that transition. I think the main advantage to me of the pension changes is I now have the freedom to choose. For example I may need to source a fairly large amount of cash, I know the tax implications, but I could get hold of it if I wanted to. If I have a good year and maybe I win the lottery, and I don t need to draw down from my pension, I can change the amount I draw down. So, from the point of view of the flexibility, that is the big advantage to me: that I don t have to say I want x thousand pounds per year for the rest of my life or for the next 5 years I can change it each year and that s a big advantage to me that I can flex my income according to my needs. My pension history is a bit of a chequered one, because I haven t skipped jobs a lot but I have had quite a few career changes. So, historically I have built up quite a lot of little pension funds and a couple of decent-sized pension funds, but all in all when I was coming up to retirement I actually had about 6 pension funds. They were just pots of cash all being managed by different people all with different charge all with different methods of drawing the money out. A lot of them were trying to sell me annuities - I didn t like it. So, that s when I decided to do something about it. Once I had made the decision to go for a SIPP, the question was how do I get all these little pots and couple of biggish pots into a SIPP. I opened the account with Hargreaves Lansdown, phoned them up, and explained what the situation was. Very helpful advice, very, very easy to move. Literally just fill in the form and then away you go, you start investing. If I wind the clock back 3 years or 2 years, but with new legislation which has just been announced, and I was going to do it all over again or somebody is about to do it what I would ask them to think about is: do you want to have the same amount of money every year? Do you want to draw a lot out at the beginning and then have a rest from it? Draw out more later on? Do you want to go on a world cruise every 5 years, if you have got the money? So, look at your lifestyle and decide how you want your income to come out. Then with a SIPP and the current legislation you can flex how much you take out. No more rules about how much you can take out based on weird calculations and percentages of annuity values. You take out what you want. You can choose how you spend your money and to me that s the biggest thing. I choose how I spend my money. Nobody else is choosing it for me, and that s the big advantage I have got from a Hargreaves Lansdown SIPP. Charlotte Cowen: So, if you have got some time to go until you retire you could consider reviewing your investments or even switching to a different type of pension that will give you more choice and freedom. But what happens if you have already retired? Have those people missed out completely? 4

Tom McPhail: Well, there s two groups of people here. First of all, if you have already bought an annuity, then you won t be able to take advantage of these new freedoms because you have already locked into a guaranteed income for life. That may well have been suitable for you anyway, but that s now a done deal. If you are in a drawdown plan, on the other hand, you will be able to take advantage of these new freedoms from next April, provided your pension provider actually gives you access to this. We know that at present some pension companies don t offer the kind of freedoms that will be available next April. I think it is also important to bear in mind that whether you are in drawdown already or you are coming up to retirement, we do anticipate there may well be quite a lot of people looking to take advantage of these new freedoms next April, so it may make sense to act sooner rather than later. Charlotte Cowen: That s great, thank you, Tom. Do you have one last message you would like to leave our viewers with? Tom McPhail: Yes, quite simply, these changes will affect 18 million people. The government is giving some great tax breaks to encourage you to save for retirement. They have gone further than that now and said it s your money, you have complete freedom over what you do with it. There are some great opportunities there, but a lot has changed, so it s absolutely imperative everybody should take another look at their pension, decide what s best for them, make sure they are making the most of these opportunities, and act now. Charlotte Cowen: That s great, thank you Tom. So, if you would like to find out further information about the new pension freedoms changes please visit www.hl.co.uk where you will find a wealth of information. Alternatively if you have any questions, queries or you would like to have a chat to someone about the changes please feel free to contact the Hargreaves Lansdown Pensions Helpdesk on 0117 980 9926. They are available during the week and on Saturday mornings as well. 5