Thousands of people who are approaching or have just reached retirement are being given much greater choice over how to use their pensions.
Until April this year, most of those who reached retirement age were effectively forced to buy an annuity – a product which swaps most or all of your pension savings for a guaranteed monthly income for the rest of your life. But under the new system, individuals are being given more freedom over how their pensions are used to pay for retirement.
It is now simpler to leave the money invested in the stock market and take a regular income from it. Meanwhile, changes to tax rules mean that pensions can be cashed in much more easily, with the money used for other investments such as buy-to-let property.
One of the main reasons for the changes was the decline in annuity rates over recent years, and the sense that annuities – which are usually irreversible once they are bought – offer poor value and little flexibility.
But while annuities are a low-risk, low-return option, the idea of leaving the whole of a pension invested in the markets – where capital is not guaranteed and is at risk from falls in share prices – may seem worrying to many people in retirement.
One alternative is to take cash out of a pension and put it in a deposit account. Like annuities, however, rates on bank savings are near rock-bottom at the moment with little prospect of an increase in the near future.
But there is another option: peer-to-peer (P2P) lending is a relatively new type of financial service which was pioneered by Zopa 10 years ago. This involves people lending their spare cash to borrowers – other private individuals – in order to generate regular returns as the loans are repaid with interest.
Effectively this service is doing what the banks do – that is, taking money from consumers and lending it to those who want to borrow. But by cutting out the middle-man and related overheads, P2P lenders can get significantly higher rates than banks savers, while borrowers get cheaper loans than on the high street.
At the moment, Zopa customers who lend for between four and five years are projected to make 5% a year by relending their funds, while returns are expected to be 3.8% for lending over two to three years.
As borrowers repay loans every month, lenders can choose to re-lend or withdraw the cash to generate a regular income.
P2P lending does however carry greater risk than putting your money in a bank account – there is a chance, for example, that a borrower may become unable to repay their loan, and returns are not guaranteed.
But there is a large amount of protection in place to stop losses from happening.
Firstly, the money you lend is shared among a large number of borrowers to spread the risk. And Zopa has a Safeguard Fund, which is a pot of money currently worth more than £8 million, although this is not a guarantee or insurance product.
If a borrower reaches a total of four months in arrears the fund automatically repays the lender that borrower’s loan in full including interest owed.
Experts expect that many retirees will take a piecemeal approach to their pensions, with some of the money used to buy an annuity and some left in the stock market.
But P2P lending offers a third way that can complement these two options, with less of the risk of shares, yet greater flexibility and higher returns than annuities.
To learn more about P2P lending through Zopa please visit our lending pages.
With P2P lending your capital is at risk.