New Pension Freedoms Mean 27% in Drawdown Fees
The Telegraph has written an article titled, ‘Rip-off fees will wipe 27% off new ‘flexible’ pensions’ and many savers will be shocked at the drawdown fees and taxes. Pensioners who think they can just cash in their new pension to buy a new property or car might be in for a bit of a shock when it comes to fees and taxes.
Brits who are lucky enough to live abroad or thinking of retiring abroad can avoid most of the drawdown fees as well as UK taxes through a transfer to a QROPS.
Tax on New UK ‘Flexible Pension’ Rules
Firstly, even though the first 25% is tax-free, the rest is charged at the highest marginal tax rate. Income tax rates are typically 20% – 40% in the UK. So, instantly, you could wipe a third or more off your pension pot just by cashing it in. Secondly, you will lose money from not investing it. Not only do you lose the investment returns, but you also lose the compound interest from keeping it invested. A pension which grows at 7% per year doubles every ten years.
So, if you take a 200k pension at 55, you get 50,000 GBP tax-free right now and the rest you can take after tax. The first 10,000 GBP is tax free, then 20% on the next 31,685 and 40% on the rest.
This means if you cash-in your pot, you would get 150,337 GBP in cash and pay 49,663 GBP in tax. So, cash in your pension and you have lost a quarter of your pot and your annual pension income would be around 7,500 GBP per year.
Now, let’s imagine that instead you invested your pension pot at 55 and left it until you are 65. Your pot would have doubled to around 400,000 GBP. If you miss taking a lump sum, you now have 20,000 GBP per year income to live off.
What would you rather do? Cash-in your pension whilst you are still relatively young and healthy at 55 and struggle perhaps working later in life with poor health or would you rather wait ten years and comfortably retire on 20,000 GBP Per year income.
If you are an expat, you can even transfer to a QROPS and avoid UK income taxes altogether as well as avoiding the taxes on demise that the UK is so fond of.
Income drawdown Fees on New ‘Flexible Pensions’ in the UK
The income drawdown fees can be particularly high. The ‘old’ pension industry set up all their charging schemes thinking that pensioners would draw their pensions once per year, so worked all their calculations out like that. SIPP drawdown fees may be as high as 50 GBP – 100 GBP per month.
Now imagine a ‘bank account’-like pension scheme that Osbourne seems to favour. Ernst & Young are already spending millions to come up with such an account to reduce SIPP drawdown fees and ‘Wisepensions’ are trying to extract your money further by making a ‘bank account’ style pension scheme linked to a credit card. Wonga, wonga, give me more money now….
Problem is that most insurance companies have not budgeted for this. Suddenly, the administrative staff is going to have huge amounts of work to do. SIPP income drawdown fees are going to become higher. Figuring out drawdown fee payments and the tax owed on those payments. Most likely situation is that they will have to automatically assume a withholding tax bracket, for example, a 40% marginal rate of income tax, which you will have to try to claim back at a later date if you drop down to a lower bracket. Good luck waiting for HMRC on giving you overpaid tax back.
Secondly, the big insurance and pension companies are going to have to charge you for it. I heard one company has a normal drawdown charge of 50 GBP on drawdown payments, but this could be up to 150 GBP on each monthly withdrawal you make. So, not only are you paying 40% income tax, but you are paying another 1200 quid a year in charges just to take your cash out. Now, your original 200k pension looks a lot more like a 100k pension in no time once you have accounted for tax, your lump sum withdrawal and any ad hoc charges from your bank account style pension scheme.
Labour are making noises about capping these charges on pensions as currently, the cap on fees is only in place on workplace schemes, not private pensions or UK SIPPs. Caps on drawdown fees should also come into place.
Labour also seem to have changed their tune on pensions…
Shadow pensions minister, Gregg McClymont has recently said:
“Labour welcomed the new pension flexibilities announced in the budget, but we are concerned that the government has not thought through the risks of rip-off charges being taken from the savings of hardworking people.”
Research by Nest found that savers are looking for protection from inflation during retirement, a guaranteed income until death, while wanting to avoid stock market volatility.
It is tough to get all three, but there are many ways to reduce volatility and protect from inflation whilst targeting a stable income. Usually, this can be achieved through a mixed strategy of holding the safety of bonds along with investing in equities. Be very careful of anyone who provides “guarantees”. This is normally only offered through buying an annuity which can pay you a fixed income, but as interest rates are so low, it maybe more prudent to take an income which fluctuates, but pays you a higher income though an equity/bond mix.