Pension freedoms: what are people doing with their pots?

Forget Ferraris: new figures suggest the over-55s are taking a "sensible approach" with their pensions since the freedoms were introduced.

More than six months have passed now since the introduction of the pension freedoms back in April, giving older people more control than ever before over what happens to their pension pots.

New figures from the Association of British Insurers have revealed just what people have been choosing to do with their own pots. Let’s take a closer look, and see which options might appeal to you.

Take the money as cash

According to the ABI, smaller pots are generally being taken as cash. In total around £2.5 billion has been paid out in lump sum payments, with an average payment of just under £15,000.

On top of that, around £2.2 billion has been paid out via income drawdown payments, with an average payment of £3,600.

This somewhat contradicts the dire warnings we saw before the introduction of the freedoms, that pensioners would splash out on fast cars, wasting the money and risking a penniless future. Instead, the ABI suggests that these relatively low figures reflect the “sensible approach” people are taking towards the new freedoms.

Once you hit the age of 55 you can get your hands on 25% of your pot in cash without paying any tax. You’ll have to pay Income Tax on the rest.

Sadly the ABI doesn't publish stats on exactly why people choose to withdraw some or all of their pot in cash. But according to Standard Life, some of the more popular reasons its own customers withdrew cash include:

Home improvements
Repaying a debt or mortgage
Having an emergency fund in the bank
Paying for a special occasion like a holiday or wedding
Getting children on the property ladder

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Income drawdown

On top of the money already received through existing income drawdown (sometimes also called flexible income), a further £2.85 billion has been invested in such products, with an average fund size of almost £65,000, according to the ABI.

With income drawdown, rather than converting your pension pot into an annuity, you instead keep the pot invested in the hope that it will continue to grow over time. You can then dip into that cash for income – in other words, draw an income from it.

As with any investment, there is plenty of risk involved here. Your pension pot is still exposed to the vagaries of the stock markets – if there is a crash then your pot could be entirely wiped out.

You also need to be careful to not withdraw too much from your pot, or else you could spend it all long before you die. What’s more, you’ll need to be hands on with your pension, regularly reviewing how your investments are performing.

However, it does come with one potentially big benefit – if you have an income drawdown product and you die, then your pot is passed onto your loved ones, potentially free of tax.

Jamie Jenkins, head of pensions strategy at Standard Life, said that choosing drawdown does not mean the same thing today as it did two years ago.

He added: "Previously, for example, people with small pots might have bought an annuity, not because they needed the income, but because they wanted to access their tax free cash and an annuity was the only way to do so. Now they have the right to access their tax free cash while staying invested in appropriate funds, minimising tax and securing wealth transfer to future generations. We expect this new drawdown market to continue to grow as it supports all of the new freedoms."

Annuities

According to the ABI’s figures, around £2.17 billion has been invested in annuities, with an average fund invested of more than £53,000.

Before the pension freedoms were introduced, the vast majority of pension pots were converted into annuities. These policies offer you a guaranteed annual income until you die. However in recent years the return from annuities has plunged to new record lows.

When the freedoms were announced, many suggested that this would prove the end for annuities. However, this hasn’t come to pass.

Dr Yvonne Braun, director for long term savings policy at the ABI, said: “Despite some ringing the death knell for annuities, this seems to have been premature. An increasing number of people are recognising the value of a guaranteed income, with annuity sales rising this quarter.”

Annuities come in a number of different forms. Standard annuities simply pay you an income until you die. Enhanced annuities are available to those with some form of illness or physical condition which affects their life expectancy, and means a higher monthly income.

Finally, there are fixed term annuities. With these you only cash in a portion of your pension pot in exchange for an annuity, keeping the rest invested. You then get a regular income for a set period (say, 10 years), after which time you can review your options and probably sign up for another annuity. As you are that much older, you may have developed a condition which means you now qualify for an enhanced annuity.

It's very important to shop around and compare what annuity you could get from a range of different providers.

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