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Pension Freedom – an inspired move or a looming calamity?

20th March 2014

In this Budget the Chancellor announced that people would effectively be able to cash in their Pension Funds without the current restrictions of having to buy an Annuity or take Drawdown income which is restricted by the rules of the Government Actuarial Department.

Some people might be tempted to withdraw the Fund and “spend it on a Lamborghini”.

Bearing in mind that a V10 Huracan costs £186,000, whilst the average personal Pension Fund in the UK amounts to only £25,000, this seems unlikely.

Indeed, freedom of pensions has been available in Australia for some time and their experience suggests that only a tiny percentage of people will withdraw their Pension Funds and spend all the money.

The new rules aren’t due to come into full force until 2015 and it seems highly likely that this facility will be strictly regulated – watch this space.

On the face of it, everybody should explore the facility.

We did some calculations for a client who has a deferred pension where the employer no longer exists so the future liquidity of the fund must be questionable. Its notional value was £179,000 and she was being offered an index-linked pension of £9,000 a year (£600 a month net).

We did some calculations on the assumption that her pension increased by 2.5% per annum to match inflation.

It is shocking to note that her total net income from this source would take almost 20 years to amount to the total value of the fund – £179k.

Indeed, her projected life expectancy was 28 years, by which time her net income would only have amounted to an extra 60%.

By contrast, we worked out what would happen if she transferred the fund to a Personal Pension.

She could draw a tax-free lump sum this year and enough in succeeding years so that her tax liability never exceeded 20%.

In this way, over 6 years, she would have been able to withdraw a net amount of about £165,000 which could steadily be paid into the new ISAs (at £15,000 a year).

The money would be hers; she could draw a tax-free income if it was all sheltered in an ISA, plan for Inheritance Tax and potentially leave a much larger Estate to her three children instead of the pension dying with her.

But be very careful!

There is an obvious danger of making unwise investment decisions or spending too much in the early years so that you live in poverty in your very old age.

Furthermore, anybody who tries to withdraw the entire fund in one go is likely to pay a substantial amount of tax, possibly 45% on some of it.

if this were the case, they would also sacrifice their personal tax allowance in the year that they withdrew the fund.

It could also bring about a bonanza for the Government. Only 25% of the Pension Fund can be withdrawn tax-free; the rest is taxable at your highest rate.

If people retain more of their wealth the Government’s “take” from Inheritance Tax could burgeon.

It is predicted that many people might withdraw their fund and invest in buy-to-let property.

If so, this could fuel a housing boom which would make it even more difficult for first-time buyers to step on to the property ladder.

Unanswered questions

Members of Public Service Pension Schemes are almost certainly going to be denied the right to withdraw their funds. Such arrangements are giant Ponzi Schemes. In other words, there are not sufficient assets to meet all the future liabilities, so contributions from today’s workers are used towards payments to today’s pensioners.

Pension Funds own large volumes of Government Stock (Gilt Edged Securities). If they seek to sell these, it could have a devastating effect on the Government’s scope to raise money from this source.

Will the Chancellor also ban transfers from all Defined Benefit (Final Salary) Pension Schemes for similar reasons? If so, this would seem highly discriminatory but the Chancellor would be defending the National interest.

Will the Local Authority now deem your Pension Fund to be a “realisable asset”?

In other words, will you be required to cash it in in order to pay the costs of long term care?


We are curious and excited about this adventurous measure but an awful lot of questions remain to be answered, of which we have posed just a few.