Cash flow forecasting reveals hidden cost of pension freedoms

As financial planners, we regularly deal with the issue of pension freedoms and the ability to extract pension lump sums at will to address particular financial needs. To many they seem like a quick, easy win, but a simple cash flow forecast often shows the pitfalls of going down this road.

Not so long ago, I was asked to consider solutions for a client who had read about pension freedoms. They wanted to make some home improvements as their disabilities were making things around the house a challenge. They were unemployed, receiving a disability living allowance and had no savings to fall back on. It was easy to see why their pension pot looked quite so attractive.

Not always what they seem

They were considering transferring their secure salary-related occupations scheme pension to their Personal Pension Plan to release a tax free lump sum. But while they were eligible to draw retirement benefits directly from the occupational scheme, it would be at a significantly reduce level as they were still some five years away from the scheme’s retirement age.

An initial examination of the scheme benefits also showed that they would have to forego some very valuable guarantees. What’s more, as they lived along and had no children, death benefits were of no particular interest and they could potentially incur a severe drop in their retirement income. But despite this, the lure of the pension lump sum was still too good for the client. We needed another way of demonstrating the true impact of this approach.

The power of cash flow forecasting

Eventually, what dissuaded the client from proceeding with a pension transfer was when we presented them with a lifetime cash flow forecast which offered two scenarios. The first, where the client received income guaranteed for life form their scheme pension. The second, from a non-guaranteed Flexi-Access Income Drawdown Plan, having first drawn a tax free lump sum to pay for home improvements. The penny dropped. It was now clear just how much income they stood to lose if they proceeded with the a transfer.

As a result, we found two other options for finding the money to fund the improvements. First up was the opportunity to apply for a Disabled Facilities Grant from their local authority and potentially receive up to £30,000 towards the cost of the improvements to their home. The second – and the one that got given the green light – was to apply for an equity release product called a ‘Lifetime Mortgage’. This gave them the cash sum required for the necessary renovations, while also allowing them to build up an emergency fund and preserve the guaranteed pension payable in five years’ time.

It just goes to show that despite the vast increase in flexibility presented by pension freedoms, your pension won’t necessarily provide the best solution.

This article first appeared in SKQ magazine. You can read the full magazine here.