A decade ago, significant changes occurred in Britain’s retirement framework with the introduction of pension freedoms on April 6, 2015. This reform dismantled the conventional requirement for individuals to convert their pension savings into an annuity—a guaranteed income for life—and granted those aged 55 and above greater autonomy over their pension funds.

This shift has had a remarkable impact. Since the reforms were enacted, nearly 7 million pension pots have been accessed, with around half of those being fully withdrawn, according to the investment manager AJ Bell. Total withdrawals since the policy changes have exceeded £83 billion, as reported by government statistics leading up to early 2024.

The excitement and concerns surrounding the pension freedoms raised crucial questions. Would individuals manage their funds wisely, or would imprudent spending jeopardize their future security? And would the once-reliable annuity market falter under these new norms?

Sir Steve Webb, who served as pensions minister during the reforms and is now a partner at consultancy Lane Clark & Peacock, noted: “It’s easy to overlook that annuity rates were exceptionally low a decade ago. Consequently, many individuals who had diligently saved were practically compelled by governmental policies to convert their pension into a meager income for life. Pension freedoms didn’t eliminate annuities; rather, they provided individuals with the opportunity to personalize their retirement financing.”

This broader range of options also meant accessing a pension became a less singular event. The ability to withdraw varying amounts from one’s pot allowed retirees to secure part of their savings as an annuity while using the remainder flexibly as needed.

According to Rachel Vahey of AJ Bell, “Retirement now differs significantly from a decade ago. Individuals don’t simply cease working; they transition more gradually. As their personal circumstances evolve, so does their financial strategy. Instead of making one definitive move, people prefer to incrementally access their pension, keeping future options available as their lives change.”

Did Savers Overspend?

Initial fears about a potential rush to withdraw pension funds for luxury items, such as sports cars, have given way to evidence of a more prudent approach. Although significant amounts have been withdrawn, the anticipated splurge on high-end goods has not occurred.

In a survey of 4,000 adults aged over 55 conducted by Standard Life, 24% reported using their pension withdrawals to support daily expenses, while 21% used the funds to reduce debt. Additionally, about 28% reinvested their withdrawals, such as in property purchases.

All pension savers may withdraw 25% of their pot tax-free starting at age 55, which will rise to 57 by 2028. A survey by Royal London of 2,012 individuals over 50 found that 32% who accessed their tax-free cash lump sum used it to pay off a mortgage or other debts, with 26% depositing the money in savings or current accounts.

The Growth of Drawdown Options

While the annuity market hasn’t disappeared, its purchases have decreased. Between October 2015 and March 2016, 16% of accessed pension policies resulted in annuity purchases according to the Financial Conduct Authority (FCA). By the latest figures, this has dropped to 10% between October 2023 and March 2024.

Nonetheless, rising interest rates have improved the appeal of annuities. The Bank of England increased the base rate 14 times from a record low of 0.1% in December 2021 to 5.25% in August 2023. The rate has since been decreased to 4.5%, with additional cuts anticipated, which may diminish annuity popularity.

Helen Morrissey of Hargreaves Lansdown commented, “Annuities are experiencing a resurgence as higher interest rates enhance available incomes. Though they no longer dominate the retirement income landscape, they still hold significant relevance for many retirees.”

However, the predominant choice among pensioners has become income drawdown. This allows individuals to withdraw funds as needed while keeping the majority invested. According to AJ Bell, drawdown options are three times more popular than annuity purchases.

AJ Bell reports that 1.6 million pots have transitioned to drawdown over the past eight years, contrasted with 560,000 annuity purchases. Many retirees employ a mixed strategy, securing part of their savings as guaranteed income while allowing the remainder to remain invested.

Retirees with smaller pension pots, specifically those valued at £30,000 or less, tend to cash in their entire pots. In 2023-24, 90% of fully cashed-in pots were valued at £30,000 or less. In stark contrast, over 80% of larger pots worth £250,000 or more opted for drawdown in the same period.

Adapting to Market Circumstances

A common guideline for those gradually drawing down their pension is to restrict withdrawals to 4% of their total to minimize the risk of depleting funds. This strategy anticipates that investment growth will surpass withdrawals.

This approach factors in a 2% annual increase to account for inflation. For instance, with a £100,000 portfolio, a retiree would draw £4,000 in the first year, followed by £4,080 in the second year.

Fidelity examined the outcomes for those who adhered to this rule, specifically someone in 2015 with a £100,000 portfolio entirely in shares. Those withdrawing only 4% annually (adjusted for inflation) would have taken out £47,000 over a decade, but their pot would have grown to £188,977 due to market gains. In contrast, those withdrawing 7% annually would have taken out £83,648 while seeing their pot grow to £131,475.

For a more typical retirement portfolio, which includes a balance of riskier and less risky assets, Fidelity analyzed scenarios for a £100,000 pension with a 60% allocation to shares and 40% to bonds.

This analysis showed that those initiating 4% withdrawals in 2015 might have a pot worth £157,892 today, while those who started with 7% withdrawals might have £109,983 left. Although the more conservative portfolio shows less current value, it also experienced reduced market volatility.

Ed Monk of Fidelity International remarked, “It’s impressive how well the 2015 cohort has fared, even with withdrawals of 6% or 7%, rates higher than common adviser recommendations. Individuals relying on investments have enjoyed favorable market conditions over the last decade, yet this isn’t always evident in real-time, with certain periods strife with unease. For instance, those withdrawing 4% (from a 100% equities portfolio) saw their savings dip below £82,000 within ten months post-retirement, prompting concerns about longevity of their funds.”

Potential Downsides

A significant drawback of the new regulations has been a shift prompting individuals to exit defined benefit (DB) schemes, which guarantee lifelong inflation-adjusted income irrespective of investment performance. In contrast, most current workplace pension schemes are defined contribution (DC), where income is contingent on accumulated savings and market performance.

Some unscrupulous financial advisers capitalized on these transitions, incentivized to recommend withdrawing from DB schemes to secure compensation upon completion of transfers. As a result, regulations were amended in October 2020 to mandate that advisers charge a standard fee for pension transfer consultations, regardless of outcomes.

Webb reiterated, “The most detrimental impact of these freedoms was the hasty transfers from DB schemes, often based on inadequate financial advice. While some DB transitions were warranted, many individuals might have been better off retaining their benefits, and retrospectively, tighter regulations might have been prudent.”

The privileges accompanying the new rules included the ability to pass on unused pension pots tax-free in the event of death before the age of 75. This enhanced the appeal of withdrawing from DB plans, which do not provide cash legacies, although some do offer income benefits for spouses. Those passing away after 75 would place their inheritors in a position to access their funds, subject to income tax rates.

However, recent announcements from Chancellor Rachel Reeves indicated that unused DC pensions would incur inheritance tax liabilities beginning in April 2027, altering expectations for many.

‘I Used My Lump Sum for Home Improvements’

Utilizing a portion of pension savings, such as the tax-free 25%, while leaving the remainder invested has gained traction among retirees.

In the six months leading up to March 2016, approximately 80,182 individuals employed this strategy, a number that surged to 145,113 during the same period in March 2024, according to FCA data.

Keeping the majority of one’s pension invested for extended durations presents advantages, particularly the potential for increased untaxed growth.

Adam Woods, 67, a former gardening business owner, opted for the 25% tax-free lump sum from his AJ Bell self-invested personal pension (SIPP) upon reaching 65, retaining the bulk of his capital invested.

Having retired that same year, he utilized his funds to construct a home extension in Tisbury, Wiltshire, where he resides with his wife, Lynn, aged 65.

“I could have opted for a luxury car, but that would have been unwise,” Woods remarked. “By adding an extension, I’m likely increasing the property’s value.”

Woods decided to maintain his investment primarily in shares, forgoing the typical recommendation of gradually reallocating to less volatile assets as retirement approaches.

This was feasible as he possesses a defined benefit pension from previous employment in the logistics sector. Together with Lynn’s earnings from her administrative role, they enjoy a comfortable lifestyle with an annual income of approximately £35,000 before taxes.

Woods added, “If I depended solely on my SIPP right now, I’d be quite concerned about market fluctuations, particularly due to recent geopolitical developments. I hope the situation stabilizes within a year or so; fortunately, I don’t need to access it immediately.” He anticipates beginning withdrawals around age 70.