Pension withdrawals are becoming more common. From 2015, people aged 55 and over have been able to take 25% of their pension investment as a tax-free lump sum. They can take the rest in cash at the standard income tax rate rather than purchase an annuity. In effect, they are selling a pension that may have been able to keep them safe financially in their retirement.
This tends to work against the whole point of an annuity: to guarantee a lifetime income based upon earnings throughout your working life. The result of this change in UK pension law is that annuity sales have dropped. The fall in annuity sales totaled 16% in the six months from November 2016 to April 2017 compared to the same six months the previous year.
Since pension deductions are made pre-tax, this represents an excellent return on investment. Almost 151,000 pension pots were withdrawn as cash during the six months ending in March this year. Although the numbers are 8% down on the previous 6 months, they are 9% above the same six month period ending in March 2016.
That said, it should be noted that 84% of full pension pot withdrawals were from pots of £20,000 or less. This situation can lead to two distinctly different problems. One is the lack of a pension. Those who fail to use their pension pot to purchase an annuity may face problems later on. An annuity provides them with an income for their entire life after retirement.
They may be unable to resist the lure of a world cruise or luxury car or blow the lot in Las Vegas. Whatever they do with the money, they will likely spend the rest of their life regretting it. Without a regular private pension, many may live for many years with very little money – nothing but their state pension.
The main problem with this is that this can result in a failing annuity market. Pension withdrawal has not reached a critical level of pension withdrawal, but it is a distinct possibility. If such behavior becomes the norm then many annuity businesses may have an issue. Business and insurance companies offering annuities should keep watch over what is happening.
Individuals with small pension pots of £20,000 or less are liable to take it as a cash handout. Annuity and pension firms will then lose out on projected profits. In fact, the annuities sector is beginning to look potentially weak.
Is there a way out for the annuities market? It seems like only government intervention could work by changing the conditions for cash pension withdrawals. Ultimately, that may also result in fewer benefit claims from those who have blown their entire pension pot. Is selling an annuity smart?