Pension changes are leaving people confused and vulnerable

Credit: SpeedKingz/Shutterstock.com

The Association of British Insurers (ABI) warned on Monday that some people are withdrawing too much from their retirement funds too soon, taking advantage of an extension to pension freedoms introduced in April 2015.

Similarly, pension provider Aegon revealed [pdf] in their fifth UK "Readiness Report" that 80% of Britons are unaware of how many years of National Insurance (NI) contributions are needed before they can qualify for the full state pension.

This unawareness comes at a time when the Government have introduced a new state pension (in April this year) that raises the required period from 30 to 35 years.

Their changes have therefore added to an already considerable state of uncertainty and unawareness, heightening the already pressing need for the Government to provide financial education and improve their communication of policy changes.

Pension freedoms

The first change to make pensions more daunting for the public was the so-called "pension freedoms" introduced in April 2015.

These allow any pension holder over 55 to withdraw as much money as they like from their pot, with any withdrawal under 25% being exempt from income tax.

The idea behind them was to introduce flexibility into the pension system, enabling holders to sell annuities that aren't ideal.

However, even though some 300,000 withdrawals have been made since their introduction, the ABI announced that some 3,379 pension pots (4% of the total) had seen at least 10% of their available funds withdrawn from them in the first three months of this year alone.

This presents the possibility of these pots running out within a decade, potentially leaving their holders penniless.

It's possible that the people withdrawing the highest percentages of their pensions may have alternative savings and sources of income, yet the high rate of withdrawal nonetheless suggests the Government's changes may be endangering the nation's most vulnerable pensioners.

Commenting on this possibility, Adrian Walker of Old Mutual Wealth said, "The figures show that in [the second quarter of] this year, on average more than £11,000 was taken out by individuals ... That suggests that some people are at risking of winding down their savings too quickly."

This worry is strengthened by the fact that 96% of holders who claimed back their entire pots in the most recent quarter cashed in less than £10,000, an exceedingly modest sum for a fund meant to support a pensioner for the rest of their lives.

What's more, in light of how Brexit has considerably dampened the prospects of the UK economy, the temptation to remove larger proportions will most likely increase over time.

Hence, while the Government partly intended their reforms to release additional money into the wider economy during a time of relative stress, these reforms may end up hurting those who need the most help.

In fact, a minority of pensioners are essentially using the new "freedoms" as an excuse to withdraw much or all of their pension with their current provider, rather than shop around for another provider who offers a better deal on their annuity.

Because of this, it's very important the Government provide them with better information and a greater understanding of what precisely they can do with their newly "liberated" funds. They need to place more emphasis on promoting such services as Pension Wise, otherwise they risk impoverishing the very people they set out to aid.

Financial illiteracy

This comes out more clearly with the more recent changes to the flat-rate state pension, which provides £155.65 per week to those with 35 years of NI contributions.

Those of pensionable age with fewer than 10 years of contributions, however, aren't entitled to any payments whatsoever under the new scheme.

The Aegon Readiness Report suggests that many such people aren't aware of their failure to qualify for even a reduced allowance. For instance, it found that 33% of adults don't know that career breaks could disqualify them from the full state pension.

This unawareness is something the Government have set out to rectify, although in a somewhat sluggish and half-hearted way. Namely, they're about to send letters to the 100,000 over-55s who lack the contributions to qualify them for any kind of pension.

For some, this may warning may come as too little, too late. This isn't simply because some people may be too old to adequately save for their later years, but also because research has consistently shown that those who fail to adequately prepare for their retirement are also under-equipped and unknowledgeable in many other respects.

For example, an influential 2011 study published in the Journal of Pension Economics and Finance demonstrated that people who fail to plan for their retirement are much less likely to be 'financially literate.'

That is, they were found to be more likely to have higher mortgages, to engage in risky high-cost borrowing, to choose mutual funds with higher fees, and to engage less in stock markets.

This is bad enough for them and their families, but the study's authors also concluded that "the cost of financial illiteracy is likely to devolve not only to the least capable individuals but also to society as a whole."

This cost to society is evident in how those who're bad at handling their money can often have poorer physical and mental health, a fact which has considerable implications for the NHS.

As such, the Government's constant tinkering with pensions is on course to disadvantage not just the more deprived, but also Britain and its economy as a whole.

This is ultimately why the Government must redouble their efforts to inform the public about the changes they have introduced. Their introduction of compulsory financial education into the national curriculum in 2014 is a good start in making the nation more financially aware, but they must do more to educate adults as well.

They shouldn't only send letters telling people that they won't have any state pension, but rather actively point them in the direction of financial advisers and courses to help them understand their options more fully.

As the Aegon report asserted again and again, people must have "early and full access to the important information" if they're to ready themselves sufficiently for their retirement. It's down to the Government to help them find it.