The perils of the pension pot draw down
Do you have a sports car that's worth more than your house?
No? Then former Chancellor George Osborne, and his former Pensions Minister Steve Webb, will be disappointed.
We are now in the third year of the changes in pension law introduced by George Osborne in April 2015.
These allow anyone over the age of 55 to take (up to) their entire pension pot as a lump sum, with the first 25per cent tax-free as usual and the rest taxed as if it were income.
Your savings can be reinvested, or spent on that life-long dream – a world cruise, a holiday home, even an exclusive sports car.
When these new freedoms came in, there was considerable anxiety in the industry that savers might have more freedom than was good for them. One of the fundamental concepts of pension saving, after all, had been that we were locking our money away where it was safe from the clutches of our most fearsome enemy.
No, that's not the taxman – it is: ourselves.
We were given incentives to save into a pension so that we could support ourselves, and not become a burden on the state, in our old age.
Pensions Minister Steve Webb explained at the time that he had full confidence in mature people's ability to deal with their financial affairs, showing restraint and that not-so-common trait: common sense.
Which brings us to the sports car. Steve famously quipped that he was "relaxed" about retirees deciding to spend £250,000 on a Lamborghini – while failing to mention that the average pension in the UK is around £25,000, far short of the cost of an elite sports car.
Back to today, and the current government's Work and Pensions Committee is now conducting a 'Pension Freedoms Inquiry' to look at how the new freedoms have gone, so far, for savers.
The Committee has heard submissions from finance professionals, charities and members of the public. There have been many examples of prudent good judgement - but also a few salutary tales of what can go wrong, when you act without professional advice.
The dangerous side of the new freedoms has been highlighted with one horror story involving a former engineer who rashly did just that: he accessed his pension savings without advice.
The man had built up a pension pot of £250,000, but drew down £120,000 in a single slice, paying heavy taxes which could have been minimised if he had just consulted a financial adviser and worked out a different drawdown strategy.
He then proceeded to blow his money in a six-month spending spree involving a new car, gambling, and drink.
As I mentioned above, funds drawn down from a pension, after you have the first 25 per cent tax free, are regarded like income for tax purposes. This means that three-quarters of what you take is taxable.
In theory, if you were a basic rate taxpayer all your days, but a good pension saver who has built up a considerable pension, you could suddenly find yourself being taxed at the higher 40 per cent tax rate for the first time in your life, if you draw down a large lump sum.
An advisor might suggest that taking smaller slices from your pension over time could enable you to avoid the higher tax rate.
The money's as good to you as it is to the taxman!
Some of the heavyweights in the pensions business, including Phil Loney, the chief executive of Royal London, have actually said that drawdown is so risky and complex that it should only be done with qualified advice.
Meanwhile the financial regulator, the FCA, has said that it will conduct a major review of non-advised drawdown cases to assess what happens when you act without advice.
It will make interesting reading: it will be interesting to see what mayhem they might uncover.
:: Michael Kennedy is an independent financial adviser and pensions specialist, and can be contacted on 028 71886005 . Further information on Facebook at “Kennedy Independent Financial Advice Ltd”.