How have pension freedoms impacted retirement planning?

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Need to know:

Increasing education about pensions is key to helping employees make the right decisions about accessing their pension savings early.
The ability to access pension funds early could prompt changes to the way that pension providers invest for their members.
New initiatives, such as the Living Pension, provide an opportunity for employers to support staff, particularly their lowest-paid employees, in saving more for their retirement.

When the government introduced the pension freedoms in 2015, it gave employees more choices about how and when they could access their pension savings, with people able to draw income directly from the fund or take the whole lot as a cash lump sum.

However, that flexibility needed to be combined with the ability to access these responsibly. Alan Morahan, director at employee benefits and workplace savings firm Punter Southall Aspire, explains: “The various options have implications and many people have not been given the necessary information they need to consider them properly. As a result, we see evidence of people making poor decisions, for example, accessing their pension pot earlier than they really need to or should do, incurring unnecessary tax charges, and transferring to more expensively managed investments.”

Retirement planning

Freedom of access to pension savings has impacted retirement strategies. Data from Legal and General Investment Management (LGIM) has shown that 50% of its members do not access their pension pot at all until aged 65, but among the much smaller proportion of members who access their pot at 55 (8%), the vast majority (90%) take a portion of their savings as a single cash lump sum.

A key reason for that trend is that more of the current generation of retirees have more diverse sources of retirement income, including defined benefit (DB) pension pots and property, says Stuart Murphy, co-head of defined contribution (DC) at LGIM. “Over time, DC pension pots will become increasingly central to members’ retirement prospects,” he says. “That will shape the behaviours of employers and employees, both of whom will have to adapt their working practices, balancing the desire for greater flexibility in work with responsible retirement planning.”

In the current cost-of-living crisis, pension freedoms may well have provided a lifeline for some people. However, the main role of pensions is to provide an income in retirement rather than being used pre-retirement to maintain a standard of living. This raises the question of whether the freedoms are still fit for purpose in terms of employees saving enough for retirement.

Stefan Lundbergh, head of DC design at Now: Pensions, says: “While savers gained flexibility, pension freedoms have not prompted enough change in how pension providers invest for their members. De-risking still begins far too early, based on the obsolete idea that investments ‘end’ when someone retires. In reality, retirement is only a mid-point. Providers need to look at the full investment term, including the many years people spend retired. Investing for longer in growth assets can deliver greater returns and help savers address the shortfall many will face if they limit themselves to minimum contributions.”

Affordability of saving

The real issue is that individuals are not saving enough to be able to afford to retire. According to an online survey of 3,059 UK working adults who paid into a pension in the last 12 months carried out on behalf of the Living Wage Foundation in February 2023, more than half of pension savers feel they will never be able to retire. A new pension standard, the Living Pension, launched by the Living Wage Foundation in March 2023 aims to help workers, particularly lower earners, build up adequate retirement savings. The voluntary savings target is 12% of a worker’s salary, of which the employer pays in at least 7%. This builds on auto-enrolment, where employers are only required to contribute 3%.

This year's Spring Budget offered a further boost to pension saving, with the announcement that the annual tax-free allowance is to increase by 50%, from £40,000 to £60,000, and the money purchase annual allowance (MPAA) would be increased from £4,000 per annum to £10,000 from April 2023.

Steve Cave, director in Evelyn Partners’ employee benefits team, says: “For those who accessed their pensions, returning to work and paying into a pension again could be problematic. Previously, if [they] access any taxable money from [their] pension plan, then the amount [they] can save into the plan will usually reduce from £40,000 to £4,000. Increasing the MPAA to £10,000 will make it easier for individuals who have taken money from their pension savings to keep working and saving.”

The move will also be welcomed by organisations that have lost employees through people taking early retirement. In fact, the Chancellor’s pension allowance changes were positioned around the objective of getting older, experienced people back into the workplace.

However, employers could do more to help employees over the retirement line which may result in people staying in work for longer when they realise how long their money has to last once they retire, says Morahan. “As well as better pension engagement and education, other strategies could include flexible-working policies and opportunities to change role, which can result in an experienced person moving to a new role, perhaps with less responsibility, but their knowledge and experience stays in the workplace,” he concludes.