New pension freedom brings choice, but also greater responsibility
17 March 2016
The recent introduction of ‘Freedom and choice’ in pensions has brought sweeping changes to the retirement landscape. There is no longer an obligation to buy an annuity. Instead, you now also have the option to leave your money invested or draw down your pension fund at your marginal rate of tax. However, with greater freedom comes more individual responsibility. Legal & General’s Emma Douglas discusses the pension reforms and the new responsibilities DC savers now face.
- The Chancellor’s introduction of new pension freedom gives individuals greater choice when it comes to accessing their retirement savings
- While today’s retirees may have other forms of retirement savings in addition to defined contribution (DC) savings, the younger generation is likely to be far more reliant on their DC pension schemes
- With greater freedom, therefore, comes greater responsibility; responsibility to save regularly from an early age and not to draw down pension savings too quickly
The initial trends from today’s retirees suggest that most are opting to take cash payments from their defined contribution (DC) pension plan, with only a minority choosing to leave their money invested or buy an annuity. However, it’s important to note that this is influenced by demographic factors. Those retiring today have relatively small DC pension pots on average and are more likely to have other forms of retirement savings such as defined benefit pension plans.
In contrast, the next generation of retirement savers will need to adopt a different approach. While this generation is likely to be the main beneficiary of innovation in the pension fund industry as a result of the regulation changes, they are also likely to be far more reliant on their DC pension schemes for generating retirement income. In addition, the responsibility to save for retirement now lies firmly with the individual, as does the responsibility not to draw down pension savings too quickly.
The founding principles of saving are simple: save as much as you can, invest for long-term growth and keep costs down. While investment managers can focus on generating returns and minimising costs for savers, the focus is now on individuals to maximise their pension contributions. As a rule of thumb, we believe that you should aim to save a percentage of income equal to half your age. In other words, a 20-year old should aim to contribute 10% of their salary to their pension, while someone aged 40 should consider contributing 20%.
Thanks to the power of compound growth, investors can increase their chances of building a larger retirement nest egg by starting to save from an early age. Compound growth is the term used to describe how long-term savers can not only receive a return on their initial capital investment, but also an additional, or ‘compounded’ return on gains made previously. While the idea of receiving a small extra return on your money might seem a little underwhelming, its effect can be very powerful in the long run. And what’s more, the earlier you start to save, the greater its effect is likely to be.
So while the new increased range of retirement choices may be grabbing all the headlines, taking responsibility for your retirement and choosing to start saving for it sooner rather than later may just prove to be the most important choice of all.
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Issued by Legal & General Investment Management Limited which is authorised and regulated by the Financial Conduct Authority. Legal & General Investment Management Limited, One Coleman Street, London EC2R 5AA