Another pensions scandal waiting to happen

Neil Faulkner looks into some worrying comments from former pensions advisor to the Government, Ros Altmann, about the mis-selling of post-pension plans.

This article is suitable for lovemoney.com readers saving into a personal or group pension. It's not written with people saving into occupational pensions (defined-benefit schemes in mind.

Ros Altmann, a renowned pensions champion and frequent thorn in Gordon Brown's side, recently told Citywire that she thought income drawdown - or Unsecured Pension (USP) as it is now known - could be the next pensions scandal, referring to sales of these plans in 2008.

Keep investing post-retirement or get a guaranteed income?

The traditional way to start drawing your pension benefits is to buy an annuity with your pension pot. A pension annuity is a guaranteed monthly income for the rest of your life, but it is criticised for its lack of flexibility and because, regardless of when you die, the remaining pot cannot normally be passed on to your heirs. What's more, you're stuck with the annuity once you've signed the paperwork.

Just as there are alternatives to saving for retirement in a pension, there is also an alternative to how you can live off your pension pot afterwards. Unsecured Pension is one of these other ways. With USP, your pot remains invested, which unlike annuities puts both the income you draw from it and the pot itself at risk from a fall in the value of your investments. However, it means that you keep control of your pot, you can choose to vary the income you receive from it (subject to maximum limits), and you can pass on what's left to your heirs (subject to taxes).

• Watch our Why you should save for a pension video.

I asked Laith Khalaf of independent adviser firm, Hargreaves Lansdown why Ros Altmann considered 2008 to be a danger year for advisers. Unsurprisingly, he concluded that it was the plunging stock market. With all investments tumbling, USP funds will have come down with them. If, at the same time, you had been advised to withdraw the maximum you're allowed as income, this could have a significant impact on your future pot and income.

Even so, whilst taking your maximum income in such a year will have an impact, it won't necessarily make a hugely dramatic difference. It's more a problem if you do this over several bad investment years. Khalaf reproduced a table that I last saw a couple of years ago. It shows what would happen to someone taking a full drawdown income, and to another person taking just half of the maximum income, over six years. The first year is a bad year for their investment pots, which is then followed by three good years, and then two more bad ones:

Sample investment returns in USP

Source: Hargreaves Lansdown. Total value with maximum income: £211,820. Total value with half maximum income: £205,669.

The gist of the table is, if you take the maximum income amount during lots of bad years, your pot will shrink dramatically. Hargreaves Lansdown also did the numbers to prove that if more of the bad years come earlier on, you'll be hit a lot harder than if your pot does well to start with and then has a bad time.

It's the double hit of poor returns and being advised to take the full income that could cause you problems and leads to accusations of mis-selling scandals, especially if you had been advised to invest in riskier assets that were hit particularly hard. Even so, as long as the market doesn't do too badly over the next few years (which is far from guaranteed), calls of a scandal may never arise.

Related how-to guide

Get ready to retire

There are a lot of things to think about as you get closer to your retirement. But the early you start to prepare, the better.

See the guide

Buyer beware

Whilst researching this piece, I did a little mystery shopping with a handful of IFAs. I'm not a qualified pension advisor, but I have pretty good knowledge on the subject (as you'd hope). Overall, I was satisfied with the quality of the advice I received. However, one advisor, Neil Dawson of Pensionsandannuities.co.uk, not long after beginning to give me advice (which I was happy with) sniffed me out rather easily. How did he do it!?

At first he thought I was an IFA, he said. His reason was because IFAs often call up pretending to be clients in order to get his advice. There are, he says, many IFAs who will 'have a go' with products and subjects they know little about, just to get a sale.

If this is happening on a large scale, there may well be a scandal in the future.

Dawson suggests that those considering USP who decide to consult IFAs should seek out those with the G60 qualification or equivalent only (which will include its recent replacement, AF3).

Do your own research

This piece should not be the end of your research. Both USP and annuities have further pros and cons, which you must look into. You need to establish which is more suitable depending on your circumstances and attitudes to risk. You need to understand the taxes that may be involved, and you need to learn how the drawdown rules change for you when you hit 75. You could, just to get started, read:  Passing on your pension when you die.

Finally, deciding how to take your pension benefits at retirement can be a tricky business. If you need more help, don't forget to ask the lovemoney.com community for help using our excellent Q&A forum.

More: You are making this pension mistake | The dangers of neglecting your pension