As over-55s get greater freedom on pensions, adviser warns that rushing in could be costly
Simon Rowe asks John Davin of Baker Tilly Mooney Moore about cashing in on retirement funds
New pension freedoms that let over-55s cash in their retirement savings early are making their mark on the personal finance sector in Northern Ireland.
For decades, annuities have been the most popular retirement savings product, paying a guaranteed income each year until death from a lump sum investment. But fixed-term annuities are only great if you live to a ripe old age and can take advantage of the income, not so good if you die early - as your money dies with you.
In April, the Government launched a radical shake-up of pension policy which means anyone aged 55 and over can now withdraw their entire pension savings as a lump sum, paying no tax on the first 25%. The rest is taxed as if it were a salary, at their income tax rate. Importantly, savers can now pass on pension pots to loved ones tax-free after death.
Approximately 85% of public sector employees and 36% of private sector employees in Northern Ireland are members of a workplace pension scheme, so is Northern Ireland's financial services sector about to see a surge in demand for people seeking to cash-in their pension pots?
"It's still early days," said John Davin, a tax expert at financial advisers Baker Tilly Mooney Moore in Belfast. "We would be advising clients not to rush in. It may be that due to poor health or particular financial circumstances the new flexibilities might be useful for you, but for the average person in their fifties or sixties, and in reasonable health, I would certainly encourage them to think long and hard about it and get expert tax advice."
Baker Tilly Mooney Moore advises a number of well-known family businesses on personal taxation and corporation tax issues. It counts credit unions, charities, solicitors and schools among its list of clients.
Northern Ireland pension experts are keen to point out that the new pension freedoms introduced in April are more relevant to defined contribution schemes such as those in the private sector rather than defined benefit pensions which predominate in the public sector.
There are distinct differences between both types of schemes.
Income from defined contribution schemes depends on factors including the amount you pay in, the fund's investment performance and the choices you make at retirement. Income from defined benefit schemes, on the other hand, is determined by a formula based on how many years you've worked and the salary you've earned rather than the value of your investment.
The UK government estimates there will be 320,000 savers each year with defined contribution pension funds, with the option to take their entire retirement fund as cash from age 55.
In the first week of the reforms after April 6, UK pension providers reported handling more than 200,000 calls from customers, with many wanting to know about the new cash option.
While Mr Davin said the new flexibilities are to be welcomed as they offer greater pension freedom, he urged caution over the tax implications and penalty charges that may accrue from exiting an old annuity product.
"The new pension freedoms are good news for people as they approach their retirement in terms of flexibility and planning what they can do in terms of passing on funds to the next generation. But it's a very complex field. It's not something that should be entered into without the right advice. You can make a decision to cash in your chips, but it can cost you quite a lot in charges and in terms of tax. If you cash in everything there are tax consequences.
"Clearly, you have to realise what pension funds are set aside for in the first instance - they are really to provide for an individual's retirement.
"If somebody at 55 cashes in 25% of his pension scheme and leaves the rest there, there is a lot less there to generate their pension when they need it at 65. I couldn't emphasise that enough."
A major driver behind the Government push for pension freedom is that annuities have taken a battering in the past decade. Annuity rates have been falling for several years, with average annual income falling 5.7% in 2014. The fall is blamed on two factors - rising longevity, which means insurers must pay income for longer, and a sharp fall in gilt yields, which are a major influence on annuity rates.
"Annuities haven't generated a good return, which is a function of the interest rates," said Mr Davin. But exiting your annuity scheme and accruing penalties "is not necessarily the most sensible thing to do," he said. "It depends on individual circumstances."