Ten years ago, the retirement landscape in Britain underwent a radical transformation. The introduction of pension freedoms on April 6, 2015, shattered the traditional path of converting hard-earned savings into an annuity — an income for life — and empowered those aged 55 and over to take more control over their pension pots.
The scale of this shift has been huge. In the decade since, nearly 7 million pension pots have been accessed, according to the wealth manager AJ Bell, about half of which have been withdrawn completely. The total amount taken out since the changes is more than £83 billion, according to the latest government figures up to the start of 2024.
The pension freedoms sparked excitement and apprehension. Would savers responsibly manage their funds, or would a wave of frivolous spending leave them vulnerable in later life? Would the annuity market, once the bedrock of retirement income, wither and die?
Sir Steve Webb was the pensions minister at the time of the reforms and is now a partner at the consultancy Lane Clark & Peacock. He said: “It is easy to forget that the annuity rates a decade ago were at rock-bottom levels. This meant that hundreds of thousands of people who had saved into a pension were more or less being forced by the government to turn their pot into a meagre income for life. Pension freedoms did not abolish annuities, but gave people the chance to shape their retirement finances in a way that worked for them.”
The wider choice also meant that taking your pension was no longer a single big life event. Instead, the flexibility to draw as much or as little from your pot as you wished allowed pensioners to use some of their savings for an annuity and use the rest as and when they needed it.
Rachel Vahey at AJ Bell said: “Retirement is very different now compared with ten years ago. People don’t just stop working overnight but transition gradually. And as their lives change, their financial approach has also evolved. Instead of making one irreversible decision, people want to phase in their pension money, keeping their options open, to match their changing lives.”
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Did savers become splurgers?
Despite initial anxieties about a mass withdrawal of pension funds to spend on luxuries such as Lamborghinis, the data indicates a more measured response. While significant sums have been withdrawn, the widely predicted spending spree on luxury goods hasn’t materialised.
In a survey of 4,000 adults aged over 55 by the pension firm Standard Life, 24 per cent used the freedom to access their pension pot to ease day-to-day finances and 21 per cent paid down debt. About 28 per cent reinvested the money, by buying property, for example.
All pension savers are entitled to take out 25 per cent of their pot tax-free from the age of 55, rising to 57 in 2028. A survey of 2,012 adults aged over 50 by the pension firm Royal London found that 32 per cent of those who took out the tax-free cash lump sum used it to pay off a home loan or other debt. About 26 per cent deposited the money in a current or savings account.
The rise of drawdown
The annuity market hasn’t vanished entirely either. Between October 2015 and March 2016, 16 per cent of accessed pension policies resulted in an annuity purchase, according to the Financial Conduct Authority (FCA), the city regulator. The latest data shows that between October 2023 and March 2024 the proportion had dipped to 10 per cent.
However, recent high interest rates have made annuities more attractive. The Bank of England raised the base rate 14 times from a record low of 0.1 per cent in December 2021 to 5.25 per cent in August 2023. It has been cut to 4.5 per cent and further cuts are expected this year, which would make annuities less popular.
Helen Morrissey at the wealth manager Hargreaves Lansdown said: “Annuities have experienced a revival, as soaring interest rates have boosted the incomes available. While they may no longer be the dominant force in the retirement income market, for many people they continue to play an important role.”
The most popular option for pensioners, however, has been income drawdown. This is where you draw money from your pension when you need it, leaving the rest invested. Drawdown is three times more popular than buying an annuity, according to AJ Bell.
AJ Bell found that 1.6 million pots have entered drawdown over the past eight years, compared with 560,000 annuity purchases. Pensioners will often use a combination of the two, buying a guaranteed income with part of their savings and leaving the rest invested to draw on.
Those with smaller pots, of £30,000 or less, are much more likely to withdraw the full amount from their pot. In 2023-24, 90 per cent of pots fully cashed in were valued at £30,000 or less, according to AJ Bell. Conversely, more than 80 per cent of the largest pots, worth £250,000 or more, were moved into drawdown in 2023-24.
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Cashing in on market conditions
One rule of thumb for those planning to gradually draw down their pension is to take only 4 per cent from it to ensure you do not run out of funds. The idea is that investment growth will more than offset any withdrawal.
The rule assumes that you increase the amount you draw by 2 per cent each year to take account of inflation. For example, if you have £100,000, you would draw £4,000 in year one and then £4,080 in year two and so on.
Using historical market data, the wealth manager Fidelity looked at how those who followed this rule fared. It looked at someone in 2015 who had a £100,000 portfolio that was 100 per cent invested in shares.
Those who drew only 4 per cent a year (rising by 2 per cent), would have withdrawn £47,000 over a decade, but they would have £188,977 left in the pot due to market gains. Those who took out 7 per cent a year would have drawn £83,648 while their pot grew to £131,475.
A more common retirement portfolio would have more in bonds, which are regarded as less risky than shares. Fidelity did the same exercise for someone with a £100,000 pension holding 60 per cent in shares and 40 per cent in bonds.
Those who started drawing 4 per cent in 2015 would have a pot worth £157,892 today while those who started drawing 7 per cent would have £109,983. While those with the more cautious portfolio have less money today in their pension, they also experienced less market volatility.
Ed Monk at Fidelity International said: “What jumps out immediately is just how well the class of 2015 have done, even if withdrawals were dialled up to 6 or 7 per cent — above what most financial advisers would recommend.
“Retirees who relied on investments have benefited from favourable market conditions over the past decade. However, this is only clear in hindsight, and there have been periods of high anxiety. For instance, those withdrawing 4 per cent (and 100 per cent in shares) saw their pot fall below £82,000 within ten months of retirement, making it seem unlikely that it would last another 30 years.”
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The downsides
One of the downsides of the new rules was that people were encouraged to move their money out of defined benefit (DB) schemes. These schemes provide an inflation-beating income for life, regardless of how the pension is invested. Now most workplace pension schemes are known as defined contribution (DC), where your income depends on how much you have saved and how your investments perform.
Some unscrupulous financial advisers were incentivised to recommend transferring out of DB schemes because they would get paid only once the transfer was made. The rules were changed in October 2020 so that advisers would have to charge a flat fee for advice on pension transfers, regardless of the outcome.
Webb said: “The biggest adverse outcome of the freedoms was the rush of transfers out of DB pension schemes in some cases on the basis of poor-quality financial advice. While DB transfers were the right answer for some, there is reason to think that others would have been better placed had they retained their benefits, and in hindsight some tighter regulatory controls might have been appropriate.”
The new rules also meant that unused pension pots could be passed on free of inheritance tax (IHT) if you died before age 75. This made it attractive to transfer out of DB pensions, which do not provide a pot of cash to pass on, although some do provide an income for a surviving spouse. If you died after age 75, your descendants could access your funds and it would be taxed at their income tax rate.
However, plans for many have been upended after the chancellor, Rachel Reeves, announced that unused DC pensions would be liable to IHT from April 2027.
‘I used my lump sum to build an extension’
Taking some money from a pension — for example, the 25 per cent that you can withdraw tax-free — and leaving the rest invested has become a popular option.
About 80,182 people did this in the six months to March 2016 but 145,113 did so in the six months to March 2024, according to the FCA.
Leaving most of your pension invested for as long as possible has its benefits, as there is potential for more untaxed growth.
Adam Woods, 67, who used to run a gardening business, took the 25 per cent tax-free lump sum from his AJ Bell self-invested personal pension (Sipp) when he turned 65, leaving the rest invested.
He retired that year, and used the money to build an extension to his home in Tisbury, Wiltshire, where he lives with his wife, Lynn, 65.
“I could have used the money to buy a Ferrari but that would have been stupid,” he said. “By building an extension I am hopefully adding to the value of the property.”
Woods chose to keep his pension pot invested mostly in shares and not gradually move money to less volatile assets, as is usually recommended when approaching retirement.
This is because he has a defined benefit pension from work he did for a logistics firm before starting his business. Together with Lynn’s income from her work in administration, they live comfortably on about £35,000 a year before tax.
Woods added: “If I was relying on my Sipp now, I would be much more worried about the market shocks caused by Trump’s tariffs. I am hoping this will all die down in about a year or so. Luckily, I don’t need to touch it now.” He hopes to start drawing on it from the age of about 70.
