The hidden danger of the latest pension change

Pensions have been in the news with unusual regularity this year, thanks to radical changes introduced in March. Further developments have been announced in the subsequent months, and the latest development is that, from April, pension funds will be accessible like a bank account, in a process called Uncrystallised Pension Fund Lump Sum, or UFPLS for short.

It's not a nice name, but the changes are relatively simple: currently, at the age of 55, people are allowed to take up to 25% of their pension as a tax-free lump sum, with the rest subject to 55% tax; UFPLS differs in that it allows people to take money from their pension whenever they want, and a quarter of each transaction will be tax free.

The general principle of UFPLS is not new - retirees are able to take multiple sums already with a process called phased drawdown, which divides a pension fund and then allows each division to be withdrawn separately, with a quarter of each one being tax free. The change, as Henry Tapper, founder of the Pension PlayPen and a director at First Actuarial, puts it, is providing "phased drawdown for the masses" because "most people didn't have the expertise behind them to be able to set up and manage phased drawdown."

However, the risks are currently controlled by the requirement to take professional advice before choosing income drawdown. This gives people the opportunity to discuss it with an adviser and be informed of the risks and whether it may or may not be a suitable option for their circumstances. Phased drawdown requires professional advice because it is not suitable for people without expertise, which should be a warning to the government that UFPLS requires regulation. In its current form though, the exposure pension holders will have to the risks is unprecedented.

Five of the most worrying aspects are:

Advice is not required

The government's repeated promise of free guidance at the point of retirement is being undermined by allowing people to have unlimited access to their pension fund without first talking to an adviser. The danger with this is that retirement planning is a complicated topic, and rash decisions can be devastating. Having immediate access to a pension with no one explaining the risks could put a lot of people in financial peril.

Tax implications

With a bank account, the amount of money withdrawn is the amount received because tax has already been applied on earnings. With UFPLS, tax is applied to 75% of each withdrawal, and this needs to be considered each time the individual wants to remove some money from their pension. If a person withdraws £100, £25 will be tax free but they will pay their marginal rate of tax on the other £75. For a basic-rate taxpayer, the tax bill will be £15, leaving them with £85. For a higher-rate taxpayer, the bill will be £30, leaving them with £70.

Pension credit card

A small pensions firm is planning to provide a credit card in 2015, allowing users to spend their pension online and in shops, and even withdraw money from cash machines. This allows for hasty purchasing decisions with no guidance or consideration of the tax implications. Full details of the product have yet to emerge, but unless there are strict safeguards in place it could be very easy for people to spend too much too quickly, leaving them in a precarious situation. 

Running out of money

Giving people freedom with their own money is a good thing, but it also carries a risk that the fund will be depleted too quickly, leaving retirees dependent on the state pension. Simple measures can be used to guard against this, such as the pledged free guidance, the list of financial advisers the Money Advice Service is compiling, and a cooling off period for withdrawals. A few days between requesting the money and receiving it could help to prevent hasty spending. The reason income drawdown requires financial advice is because of the risks, including investments underperforming and reducing the size of the pension fund, and spending the money too quickly. These risks are still present with UFPLS. With the new freedom, people could also find themselves facing a large and unexpected tax bill, which they may only be able to pay off by taking more money from the pension. Despite what the headlines claim, a pension is not a bank account and should not be thought of as one - a pension has a specific purpose of providing an income throughout retirement. Managing it so that it lasts for the rest of your life is a challenging task - it's easy to overspend, but it's equally easy to be too afraid of it running out and denying yourself a comfortable retirement.

Providers could be vulnerable

Pension holders will not need advice to withdraw money from their fund, so there is a possibility that if providers act on the client's request and it turns out to be detrimental to that person's finances, the providers may leave themselves vulnerable to legal action. On the other hand, if the providers recommend the client seeks independent advice before making a decision, the client may transfer to a different scheme where they will be able to access the money quicker.

The reality is that withdrawing money from a pension is not right for everyone, and regulated advice will explain that to the client. Allowing that advice to be bypassed poses a big risk, and this could be the start of a repeat of the PPI scandal. As a result of that, the banks were punished retrospectively on the basis of treating customers fairly, and there's a strong possibility that pension providers will be wary of similar action happening to them in the future if clear advice from the FCA is not provided.

As one of the UK's largest pension specialists, we provide FCA-regulated advice to help you make the best decision for your circumstances. If you would like to know more about the new changes taking effect in April or want a free pension review to see how healthy your pension is, call us on 0800 304 7600.

Call 0800 304 7288 for a friendly chat about your pension

The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article. For our latest information and news, please see our articles section:

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