Is FOMO going to leave you choosing between heating and eating?

Over 55’s are burning a hole in their pension savings even when they don’t need to according to data published by HM Revenue and Customs. According to the data 336,000 over 55’s withdrew a record ￡2.75bn from their pensions between March and June 2019. Since the flexible pension rules were introduced in 2015, more than ￡28bn has been withdrawn from pension funds by nearly 2.2 million people and a large percentage of these were still working and didn’t really need it.

But why is this the case?

Let’s explore some of the factors......

1.    “I’m afraid the government might change the rules’.

Throughout the year and especially as the budget approaches, there are rumours that the Government might take away some of the tax efficient benefits of a pension or remove the right to take the pension flexibly or take the tax free cash, also known as pension commencement lump cum.

If the government changes the rule’s on tax relief for the contributions to your pension, this will impact monies being paid in and not withdrawn and should therefore not impact the monies already built up. If they do announce changes to the tax free element or the flexibility of pensions, it is likely that there will be a date in the future when the new rules would take effect or that they would only take effect on pensions after a certain date. When the new flexible rules were announced, there were over 12 months before the rules came to fruition. This would be needed in any reversal of the rules to allow the industry to change their systems and new products be developed etc. This means that people would have time to take advice and make decisions in line with whatever the rule change was and the new rules that were coming into effect.

2.    “I don’t believe in pensions, I want the money where I can see it.”

Over the years pensions have had a bad reputation, in some cases for very valid reasons but what people don’t realise is that pensions, ISAs, Investment accounts are just tax wrappers with a different name.

If you invested in the same fund, with the same charges and the same investment amount there would be a difference in the return you would get and that is the impact of different tax regimes on different investments.

A personal pension plan is now just another type of investment. If you have your pension invested on a Platform you can see it online, you can change the funds and now you can access it, fully if you wish (subject to tax charges) from 55. It is tangible, you can see it and it is yours to access that no one else can access whilst you’re alive. Why would you not invest in something that you get at least a 20% uplift on the money you put in, can access 25% tax free in retirement and when you die it passes to your beneficiaries tax efficiently?

If your bank had a sign in the window that said ‘Basic rate taxpayers, you pay ￡80 in and we’ll top it up to ￡100 and Higher rate taxpayers, you pay ￡60 in and we will top it up to ￡100’, they would have a queue around the block, that’s part of what a pension does.

Having money in cash over the long term is a big mistake, cash is the silent killer because of inflation. Having too much money in cash is like gripping a snowball, you don’t realise its melting before your eyes. That’s inflation.

If someone had taken money out of investments during the credit crunch or even just after when the recovery had started, for example 10 years ago and put it in the bank. Let’s say they got 1.5% over the last 10 years, they would have made 15% return in total. If inflation is at least 2% pa (which is conservative), then you have actually lost 5% in real terms and let’s be honest, the things retirees spend their money on (food, fuel, household costs), have gone up by more than 2% pa on average meaning the situation is even worse. In comparison, the FTSE100 during that time has done 119.33% (Source Analytics to 15/08/19). People are paying dearly for their need to have the money where they can ‘see’ it.

3.    FOMO - What is FOMO I hear you say?

FOMO is the ‘fear of missing out’ can also be known as ‘keeping up with the Jones’s’. People see their friends taking money out of their funds and going on holiday or buying a new kitchen and they have the inevitable conversation in the pub or during a lovely evening out of ‘Yeah, I took the lump sum out of my pension, it was really easy you should do it’ and they take their friends ‘advice’ and do the same.

Everybody’s financial situation is unique and just because your friend has done something doesn’t mean that you should as well (they maybe shouldn’t have done it in the first place).

Consider working with a financial adviser that will challenge you on why you are making these decisions. A financial adviser’s job is not to let you do the things you want to do but to help you make the decisions you need to make so that your future financial self will thank you. Sometimes, it’s more important for us to stop you doing the wrong thing at the wrong time with the wrong money.

4.    “I want to enjoy my pension, my Dad dropped dead 12 months after retirement’.

This may be true and unfortunately, none of us know how long we are going to live however in the main, people are living longer.  As a financial planner I am more aware than most about our own mortality as we look after death claims and critical illness claims for people of all ages, from children to great great grandparents. We believe you should enjoy today so that you have lived your life if you aren't here tomorrow but save enough for tomorrow so that if you are one of the lucky ones that lives a long life, you can enjoy that as well.

If we all knew when we were going to die, we’d take life cover out the day before and blow all our savings having a fantastic time, but it simply isn’t realistic.

The average age for a female’s mortality is currently 88 and for men is 86 (source: ONS) but does that mean you are going to live that long? Who knows! What I do know is that it would be a pretty miserable existence if you’ve blown all your money at 55 for fear of not living a long life and then choosing between heating and eating in your retirement or having to work longer than you wanted to as you thought you’d have passed on to whatever you believe comes next by that point.

As new pensions can be passed to whomever you like via a successor’s drawdown plan, even if you do die prematurely your loved ones will still see the benefit of that tax efficient vehicle which they have inherited. If your pension set up in the right way and you have completed your nomination of beneficiary form, a Personal pension plan shouldn’t die with you. Albeit, you won’t see the benefit from it but someone you care about will.

What are the other implications?

1.    Paying too much tax – Unless you have an enhanced level of tax-free cash, only 25% of your personal pension fund is tax free. Any more than this and you will be paying income tax (depending on your other earnings). By withdrawing money from your pensions, you might be paying unnecessary tax which you cannot reclaim or offset elsewhere.

2.    You will activate the Money Purchase Annual Allowance – if you take anything more than the tax-free lump sum, you are restricted on the amount you can put back into a pension. That level currently stands at ￡4,000 gross per annum. This means that if you are still working and benefitting from your employer payments, they may have to be reduced due to you drawing on your pension.

3.    Diminishing the fund– If you take too much out of your pension there may not be enough to provide an income when you do retire. This may mean you have to take more risk than is appropriate to chase better returns, sell other assets like your home or reduce your lifestyle accordingly…....Was that new kitchen really worth it?

4.    ‘Pound Cost Ravaging’ – This is where you withdraw funds when the markets have dropped. This means you have to surrender more shares to generate a particular amount of income or capital and therefore there are a lower number of shares remaining in the portfolio for when the markets increase meaning these have to work a lot harder or perform a lot better to get back to where you were.

So, what is the solution?

• The first thing is don’t panic over something you cannot control. If the government changes the rules, cross that bridge at the time. The other impacts such as inflation and diminishing of the fund are things that we can be sure will happen and will impact you following a withdrawal so be more afraid of these than something that may or may not happen.
• Engage with an adviser to make sure your pension is set up in such a way that you can see it online and you can benefit from the latest rules if that is what is right for your situation.
• Have a financial forecast done to see the impact of your decisions.
• If you are still working, leave your pension until retirement. If you die before then so be it, your beneficiaries will get the benefit of the funds but it shouldn’t die with you. Make sure you have filled in your nomination of beneficiary forms to ensure this happens.
• Don’t think of it as a pension, think of it as a very efficient tax wrapper.
• Don’t listen to the ‘mate in the pub’. Seek some real advice. Yes you might have to pay but the cost of amateur ‘advice’ will cost you more in the long term.
• Put more in! If you are worried about the government ‘scrapping’ tax relief, enjoy it whilst it is still available.

Speak to us at KBA FS Ltd on 01942 889883 so we can go through your individual circumstances to ensure you are on the right track.

Sarah Hogan, CEO

Chartered Financial Planner & Fellow of the PFS

www.kbafinancial.com