What decisions have pension savers made over the past ten years of pension freedoms?

As of April 2015, older savers no longer need to purchase an annuity in order to withdraw funds straight from their pension

We examine the effects of pension freedoms and the spending patterns of savers.

Pension savers were given a new right ten years ago: starting at age 55, they could withdraw money from their pension funds however they wanted.

Steve Webb, the pensions minister at the time, joked that they could spend their retirement funds on anything they wanted, including a Lamborghini, and that they could use their pension pots like a cash machine. They also no longer needed to purchase an annuity.

Annuity sales fell precipitously after the new regulations, known as "pension freedoms," went into effect on April 6, 2015. To take advantage of the flexibility, most savers chose income drawdown, which allowed them to access their funds at any time.

The regulations are "the biggest pensions shake-up in a generation," according to Rachel Vahey, head of public policy at the investment platform AJ Bell.

"We will be lighting the candles on the cake to celebrate ten years of pension freedoms next month," she says. The 2014 budget bombshell from George Osborne, which revealed the new regulations, was a dramatic move that upended the rulebook and granted individuals greater discretion over how they access their pension funds.

What decisions have pension savers made, how have they exercised their freedoms, and what have they done with their nest eggs?

Remarkably, only 5% of respondents would spend their retirement funds on a fancy car, while over one-third would use them wisely, for example, to help family members or make home improvements, according to a BFIA survey. ).

In what ways have the savers accessed their pension funds?

According to AJ Bell, approximately seven million pension pots have been accessed for the first time since April 2015.

Approximately 75% of defined contribution (DC) pension plans were used to purchase an annuity prior to the introduction of pension freedoms. In 2023 - 2024, however, that fell to less than 10 percent as annuities rapidly lost their appeal.

According to AJ Bell, 60% of users who could access pots of 30,000 or more last year chose drawdown.

However, because of recent increases in gilt yields and interest rates, annuities have grown in popularity once more. The Association of British Insurers reports a 24% increase in annuity sales last year.

One of the most important retirement questions for pension savers who choose drawdown is how much money to take out. When you first retire, you could use your life savings to treat yourself to a vacation and a few extras, but how do you make the remainder of your pension last as long as you do?

This could be an issue with pension freedoms because, unlike purchasing an annuity, which guarantees you a cash flow for the remainder of your life, you have to manage your own savings.

It is typical to withdraw 8% or more of one's annual pension income, according to AJ Bell, but this also reflects the large number of smaller pots that are rapidly depleted.

Last year, 65 percent of people with £100,000 or more in their pension pot took out less than 6 percent of their income, and 44 percent took out less than 4 percent, according to AJ Bell.

The 4 percent pension rule, which is taking 4 percent of your pension as income each year, can help savers sustainably withdraw their money so they don't run out when they retire.

Many savers with modest pension funds (less than £30,000) decided to take all of their money out at once. It is likely that they have additional pensions, such as the state pension and a defined benefit pension, which will continue to pay them until they pass away.

According to research by the insurance company Royal London, 1 in 12 people over 55 (8 percent) cashed in one or more of their pots using the pension freedoms.

Spending the lump sum, which is tax-free.

The tax-free portion of a pension pot has continued to be a significant aspect of the retirement savings landscape, despite concerns that the government may eliminate or drastically cut the 25% tax-free lump sum.

According to Royal London, more than half (55 percent) of those who could have received a tax-free lump sum opted to receive no more than 25 percent of their pension.

Additionally, it discovered that one in twelve savers used their tax-free funds within six months of turning 55, which is currently the earliest age at which the majority of people can access their pension funds.

What are the ways in which pension savers have been using this tax-free money?

Pension savers' tax-free expenditures are displayed in a pie chart.

A Royal London survey of adults aged 50 and over found that nearly a third (32 percent) of those who took out a tax-free cash lump sum used it to pay off a mortgage or other debt, such as a credit card or auto loan.

More than a quarter (26 percent) of those who chose to take a tax-free amount merely put the money into a savings or bank account, while nearly one in five (19 percent) used it for home renovations and one in twelve (8 percent) distributed it to family members.

"Pension freedoms were intended to give consumers more flexibility and choice about their retirement, and they've certainly done that," says Clare Moffat, a pensions and tax expert with Royal London. We have not found much evidence of people using their retirement funds to purchase a Lamborghini, despite remarks made at the time to that effect.

This prudent strategy for allocating the pension's tax-free lump sum is reflected in a BFIA snapshot poll.

21 percent said they would put the money in a savings account, while more than a third (37 percent) said they would use it to help family or upgrade their home.

Approximately 25% of respondents stated they would put it into their pension, while 14% stated they would use the tax-free money for other purposes.

Just 5% would purchase a fancy car with the money.

It's vital to note, though, that taking the tax-free money out and putting it in a savings account might not be the best course of action. This is due to the fact that funds can grow tax-free while they are in a pension, but any interest earned after they are withdrawn and placed in a savings account is subject to income tax.

Using a cash ISA, which is tax-free, or leaving the money in the pension and taking it out only when you're ready to spend it are two ways to get around this.

The danger of choosing poorly.

It's a big decision to decide how to access your pension pot. The purpose of these life savings is to finance your retirement, which may last for 20 or 30 years. There is now even more complexity because of the introduction of the pension freedom rules.

Another issue is taxation: although 25% of each pension fund is exempt from taxes, the remaining portion is taxable.

In order to determine the best way to manage their nest eggs, some pension savers choose to pay for financial advice or get direction from the free government-backed program Pension Wise.

But according to Royal London, nearly one in five (18 percent) of people who were eligible to withdraw money from their pension had not sought any advice at all before doing so, from friends and family or financial experts.

Of customers 50 years of age or older who had a personal or workplace pension, only 20% used Pension Wise.

Furthermore, only 40% of respondents considered the tax ramifications of taking a taxable lump sum withdrawal from their pension.

The pension freedom changes have forced consumers to make tough choices that may impact their quality of life for years to come, according to Moffat.

"The fact that so few people used free guidance services like Pension Wise or sought financial advice is alarming. Our research reveals that many people made decisions that might not have been optimal for them in the long run, which is concerning.

"We would advise anyone who is faced with difficult financial decisions to consult a financial advisor; it could be a wise investment of both time and money.

Were the pension freedoms beneficial?

Since the pension freedoms were implemented, the overwhelming majority of people (84 percent) who have accessed their retirement funds say they have profited from it, with 46 percent saying they have benefited greatly.

This is in line with Standard Life's research, which was carried out last month. Seventy-nine percent of respondents say they prefer having the freedom to use their pension however they see fit.

In contrast to initial concerns that people would spend their pension funds on Lamborghinis right away, savers have utilized their pension funds more gradually, whether to ease daily expenses (24 percent), settle debt (21 percent), or make investments for the future (28 percent).

Standard Life's retirement savings director, Mike Ambery, says: "Most retirees have used their savings sparingly, but pension freedoms have given them more control over their financial future. Fortunately, the majority of retirees appear to have a positive opinion of pension freedoms.

Nevertheless, it's important to note a few beneficial aspects that retirees shouldn't depend on indefinitely, such as the fact that robust equity market returns over the previous ten years have formed a powerful tailwind.

Despite this optimism, 42% of people 50 and older who participated in the Royal London survey expressed concern about running out of money in retirement.

If you prefer security and peace of mind over flexibility, an annuity might be the best option for you. If you choose not to use the pension freedoms, you are under no obligation to.

Consider that a "mix and match" strategy may be the best choice for certain individuals, taking out the tax-free funds and possibly some additional funds to pay for necessities and a few extras at the beginning of retirement and using the remaining pension fund to purchase an annuity later on.