Since the pensions freedom reforms of April 2015, many pensions savers have seized the opportunity to take a regular income from their pension after retirement, instead of buying an annuity as soon as they hit 65. However, while there are many benefits to keeping your money invested within your pension plan and only taking an income as needed, people who opt to do this must think carefully about how they will manage their savings as they grow older.
In the first year alone following the reforms, 232,000 people over the age of 55 opted to draw money directly from their pension funds. Each of them is now responsible for ensuring they manage their savings carefully – not taking out too much too early and investing what’s remaining wisely for the future. This is no simple task: investment returns can be volatile and unpredictable, and most people have no idea how long they’ll live for or what problems they’ll face later in live – whether they’ll need expensive care, for example.
One particular concern is that thousands of people in drawdown plans will develop age-related conditions such as dementia that leave them incapable of looking after their affairs – especially complex matters such as pension-fund withdrawals and investment. Those with no back-up plan for managing their money could be very vulnerable – both before their condition is diagnosed, when their decision-making may be impaired, and later on when family and friends may struggle to sort out their finances.
So it’s worth checking what processes drawdown providers have in place to help prevent people getting into these sort of difficulties – do they have alert systems that kick in when unusual withdrawals are made from pensions, for example? However, drawdown savers can also protect themselves by establishing a “lasting power of attorney” (LPA) very early on in their retirement.
An LPA covering property and financial affairs gives named individuals – “the attorneys” in legal terms – the power to make financial decisions on your behalf if you lack the capacity to do so. You can also set up a health and welfare LPA to empower your attorneys to make these sorts of decisions if necessary. Most LPAs are set up alongside a will, typically with the help of a solicitor, but you can also make the arrangements directly through the Office of the Public Guardian. Each LPA costs £110 to register, plus the legal fees charged by your solicitor, but such costs may be a small price to pay to protect your finances later in life.
However, even if you don’t ever need to make use of your LPA, you should still think about how long it will be appropriate to remain in a drawdown scheme. It’s not just that the challenges of managing drawdown arrangements mount up as you get older – though they do for many people – but also that the alternative becomes more attractive. A pension fund invested in an annuity at age 75 would buy an annual income worth roughly 50% more than the same amount invested in annuity at age 65.
Moreover, at age 75, the rules on tax on inherited pensions become less attractive for those in drawdown schemes. Prior to reaching 75, savers are usually able to pass money in their pensions on to their heirs with no tax liability at all. But thereafter such cash is subject to income tax, just as any annuity income you bequeath to your heirs would be.
For these reasons, some financial advisers think that large numbers of people who initially opt for drawdown will decide to use their remaining pension funds to buy a guaranteed lifetime annuity income once they reach 75. They will have secured a better-value annuity by waiting longer to make the purchase, and can then avoid the worry of managing their pension savings in later life.