In this article I explain why it’s often best for people with small pension pots to spend their income before they get to state pension age. The over-prudent who hold back – can risk losing out on pension credit. The key to resolving this problem is to get people to understand their state pension forecasts and get savvy with the complex world of benefits – before they get to state pension age. I am arguing that this is a job for everyone who provides customer support in pensions, not just Money Helper and Pension Wise. It’s part of the duty we have to consumers.
We are moving to a new relationship between a financial services customer and the service provider- one defined by the FCA’s “consumer duty”, the rules behind this duty will require firms to focus on supporting and empowering their customers to make good financial decisions and avoiding foreseeable harm at every stage of the customer relationship. Firms will have to provide consumers with information they can understand, offer products and service that are fit for purpose and provide helpful customer service.
There are a substantial proportion of people retired today who are missing out on £1.7bn pa in pension credits, estimates are that 850,000 people not only miss out on the pension credit itself (around £2,000 pa) but they also miss out on “door to more” benefits such as council tax-relief , housing benefit and the much publicised free TV licence.
What is less well known is that each year, people are reaching state pension age and being rejected for pension credit even though they appear to qualify. They are being rejected for the most bizarre of reasons – for “deemed income”.
“Notional income” – the most mysterious concept in pensions!
Notional income (also called “deemed income”) is income someone does not actually get but is treated as getting. The DWP say they may treat them as having notional income when they have not taken income available to them under a personal pension plan.
This notional income is assessed by converting the value of your pot/s at rates determined by the Government Actuary – into income. A £10,000 pot might have a notional income of £800 for a 67 year old.
Say you make a pension credit claim because you get £170 per week against the £182.60 pension credit income limit, that £800 pa or £16 pw would be enough to bar you from pension credit and attendant benefits (£16+£170 =£186)
But if , between 55 and 67 you had spent that £10,000 on y0urself, for whatever reason, you would have a pension credit claim – and all the goodies that go with it. £170 is <£182.50!
Notional income is a virtually unknown concept but it is highly dangerous to the later life finances of people with small pots and limited state pension.
How can you work out if you have a notional income problem?
If you have a full state pension , notional income is unlikely to affect you. You can only get pension credit when you get the full state pension if you have a disability or care for someone.
But you can foresee whether you aren’t going to get the full state pension from your early fifties using the state pension forecast.
In this case, the forecasted income is below the full state pension, this person has – if they have no other income at 67, a pension credit claim.
So this person is going to have to make a complex decision at some point over the next six and a bit years.
Do I spend down my pot and give myself a right to pension credit?
Or do I forego pension credit and rely on a limited state pension and whatever I get from my pension savings?
The answer to that question is down to the individual, it depends on all kinds of things, including
- capacity to work
- willingness to work
- current savings
- likely future savings (including inheritances )
- caring duties
But what we can say with a degree of certainty is that most people with small pots and a forecast shortfall against a full state pension , would be better off not having notional income from pensions. To be blunt, these people should spend down their pension savings before state pension age.
But can you give people that guidance? I think you can give them the facts. Martin Lewis does this as a matter of course. We need to agree a way of explaining this where the messaging is positive and does not bring pension saving into disrepute. And we need to be aware and not fall foul of what the DWP calls “deprivation”.
The DWP have rules in place to stop people deliberately depriving themselves of capital or income to get extra benefits. The problem is known in Australia as “double dipping” – you have your cake and then eat someone else’s.
But the pension freedoms make enforcing deprivation rules on small pots impossible. People now have the right to draw their pot as they choose and – so long as they take the tax consequences, the state has given them the right to take 100% of their pot before they get to state pension age.
The pension credit deprivation rule worked well in the days when people had to exchange their pension pot for an annuity , but pension freedoms have made it unenforceable.
Many people still see explaining these things to financially vulnerable as incentivising “deprivation” but I am not one of them.
What we can and should say.
I believe that Money Helper, the support teams of commercial master trusts and of insurers that help people understand their investment pathways, need to have particular care for people with small pots.
The guidance should be clear; CHECK YOUR STATE PENSION FORECAST BEFORE TAKING ANY DECISION.
If you have a full state pension entitlement, you are unlikely to be caught by notional income, all investment pathways are open to you, including buying an annuity or setting up a drawdown plan.
But if you don’t have a full state pension entitlement and you have a small pot/s (anything less than £30,000), you should consider drawing down that pot between now and state pension age, lest you lose an entitlement.
And remember this is not all about you, remember pension credit is calculated on your household, if you live with someone and you’re considered a couple, then you will be assessed as a couple and get a couple’s pension credit allowance. Your partner may well also have a problem with small pots and the notional income they produce. So you need to plan together.
Back to the consumer duty.
One way of looking at the consumer duty of a pension provider – even a pension pot provider – is that they got you into a pension and it’s now their duty to get you out of one! That is really what is happening with the retirement income covenant in Australia where providers are deemed responsible for making sure their customers get the best pension possible.
I think that considerably more support is going to be needed in helping people with small pots – than has been anticipated.
The problem with notional income is complicated, I have only touched the surface of the complexities some people – especially when deciding as couples – need to take on how they spend their pots.
And though I am a fan of a pension – an AgeWage that lasts as long as we do – I am also pragmatic. If the wage could be paid by the state as pension credit, if pension credit opens the door to more, then buying an annuity or CDC style pension – or trying to set up lifetime drawdown – or even leaving capital for the kids – IS NOT A GOOD IDEA.
We need to make our pension support teams aware of this and find ways to message this that are not deemed advice or as encouraging feckless behavior. This goes for MaPs too.
Financial advisers should also be aware of this, though most clients who pay advisory fees are unlikely to be claiming pension credit.
I will be talking to the bosses of several of our life companies , master trusts and MaPS on this shortly. I’ll be interested in feedback.
Are people smarter than I think?
We know that a huge number of small pots are being cashed out and spent, some are being transferred to savings accounts (which incidentally will only be taken into account for pension credit if greater than £10k) but most of the cash is spent on repaying debt and on windfall purchases.
This is “benefit smart” behavior. Whether by luck or judgement, many people are clearing out any liability to notional or deemed income.
The worry is that those scrupulous people who hang on to their limited pension pots, deprive themselves in their fifties and sixties, only to fall foul of pension credit rules – ending up with less all round.
Is this a case of the prudent being hit by the unintended consequences of auto-enrolment? I think it is.
When Alistair Darling first launched Pension Credit he proudly declared “it will now always pay to save”. That was an excellent ambition on his part. So what’s gone wrong that you now feel that people are losing out because they saved up a modest pension pot?
I’m not sure that things have “gone wrong”. Most people are saving more for their retirement because of auto-enrolment and people can still save £10k in personal savings without being caught by the pension credit means test. Alistair Darling , 25 years on , should be pleased.
What’s happened since 2012 is that people no longer choose to save but are enrolled into saving and from 2015 , people no longer save for a pension but save for retirement. The “deemed income” rule was there to stop people putting off buying an annuity but that’s no longer an issue, the issue is how people spend their retirement savings.
So in a quarter of a century, the retirement landscape has changed – generally for the better, but for some – the ones who qualify for pension credit, retirement savings in a DC pot are more of a menace than a help.
“…£10k… without being caught…by means test”
I think for some benefits a lower figure of £6k applies.
Where is Gareth Morgan’s knowledge when you want him?
This is not a new issue. Back in 2006 discussions were held with the DWP, to highlight the proposed AE Employer contribution for low paid and under pensioned individuals was in fact a backdoor tax on Employers to save DWP paying out excessive means tested benefits such as Pensions credit. This was one of the key reasons why The State Basic and State 2nd pesion were rationalised, and low paid not automatically auto enrolled. The 2017 AE review in its recomendations ignored these issues. Bringing in the proposed 2017 recommendations in the mid 20’s will just exacerbate the small pot issue interacting with Pension Credit.
This will mean that DWP & Treasury will need to review their current Pebnsion & Pension Credit rules.
This assumes, I think, that you cannot improve your state pension. If you can eg by working, claiming carers benefit no credit, paying voluntary contributions or in another way, isn’t that worth exploring too?
It’s an obvious but good point Martin. I’m starting out thinking of those who reach SPA without much capacity to earn or care – but need a little more – especially at the moment