Picking up speed
Written by David Adams
It is probably fair to say that if the average UK citizen thinks about pensions at all, their thoughts are a mix of confusion and anxiety. But a huge number of UK workers are being forced to think about pensions today, as they choose whether or not to opt out of pension schemes into which they are being placed automatically under the government’s auto-enrolment (AE) initiative.
Many more people than usual also found themselves thinking about pensions after Chancellor of the Exchequer George Osborne announced, in his March 2014 UK Budget, that from April 2015, anyone in the UK who is aged 55 or over and a member of a defined contribution (DC) pension scheme will be able to access their whole pension pot and spend it as they wish. Previously, most savers had been funnelled towards buying an annuity.
Meanwhile, the government is also introducing a cap on the charges imposed by providers of AE schemes, of 0.75 per cent; and is forcing providers to notify scheme members of all transaction costs.
These changes are designed to improve a complex and partially dysfunctional system. The present government has also made changes to state pensions, introducing reforms that will see the state pension age rise, from 65 today to 66 by 2020, 67 in the late 2020s, then 68 and 69 in the 2030s and 2040s.
It has introduced a ‘triple lock’ of protection for the state pension, ensuring the benefit provided rises annually in line with whichever is highest: wages, the rate of inflation, or 2.5 per cent. These changes and the scrapping of a complex means-testing system means that within the next decade pensioners will know they will receive about £7,500 per year from this first pillar of the system.
In the second pillar, one theme of recent years has been the closure to new members or to future accrual of defined benefit (DB) pension schemes, which often provide a relatively generous income in retirement, but can represent a significant liability for sponsoring employers. The total liabilities of UK DB schemes are thought to be worth about £1.8 trillion. An entire sub-section of the UK pensions industry now focuses on removing this burden from the sponsoring employer through de-risking transactions.
DC money purchase schemes have been seen as offering low value to the saver, particularly as at present every financial factor is driving annuity rates down, so that even a DC pension pot of £100,000 or more – and many workers’ pension savings amount to around £30,000 at retirement – would offer an income through an annuity of just a few thousand pounds a year.
The changes announced in the Budget would not destroy the £12 billion UK annuities market, Pensions Minister Steve Webb told Parliament the day after the announcement, but would offer “an opportunity for the annuity market to provide new and innovative products”. Webb also promised “a guidance guarantee offering impartial advice on pension options... throughout the decumulation process”.
Exactly how the “impartial advice” spoken of by Osborne and Webb will be delivered is yet to be finalised. Someone will have to pay for it: PwC has suggested that the cost of delivering free face-to-face guidance for DC scheme members at retirement could reach £120 million per year. And the system must be in place before April 2015.
“The current system didn’t work,” says AE provider The People’s Pension head of policy Darren Philp. “I see [the changes] as a shot in the arm for pension savings.”
Others were horrified. Dr David Blake, professor of pension economics at Cass Business School, City University and director of the Pensions Institute, told sister title Pensions Age: “This is sheer vandalism... We have the world’s biggest annuity market and it’s been destroyed. And the eyes are opening of ... snake oil salesmen who can see this money and will be trying to get it put into ‘interesting’ investments for vulnerable 80 year olds.”
But most observers, including Blake, rejected the suggestion that the average pensioner, given the chance to get their hands on their whole pension pot, would squander it on luxury goods or risky investments, and then have to live on the state pension. The real problem, suggests Legal & General director of strategy Tim Gosden, might be people doing things they think are sensible, like using much or all of their pension pot to pay off mortgages or other debts.
It now seems likely that most people with smaller pension pots, of £10,000 to £50,000, will withdraw most or all of this money and not buy an annuity. A drop in individual annuity sales could have negative effects on annuity rates, making the products even less attractive.
The hope must be that there will instead now be an incentive for annuities providers to improve their products. The UK already has an innovative annuities market, particularly in enhanced annuities for individuals with reduced life expectancy. There will now be more product development, perhaps around variable annuities, or in hybrid solutions where a guaranteed income or minimum return is backed with some kind of risk-linked investment.
Annuity providers will also surely develop new drawdown products – but these usually require more active management from the retiree. Many people may conclude that the simplicity and guaranteed income an annuity offers will make it more attractive, even if they buy it at a later stage, rather than at the point of retirement.
Another change announced in the Budget could also affect the pensions system: a rise in the amount of money that can be saved in tax-free Individual Savings Accounts (ISAs), to around £15,000 per year. Some savers may conclude that using ISAs is an easier way to save for the future than dealing with a pension provider.
The deciding factor could be the way tax relief is applied to pensions, a question that may yet be revisited. Webb has suggested that a flat rate system of 30 per cent tax relief should be implemented. The present system is seen by some as over-generous to higher earners: about £25 billion of the £35 billion paid in pension tax relief goes to higher rate taxpayers. A think tank, the Centre for Policy Studies (CPS), suggests the government scrap tax relief on pension contributions and replace it with a contribution from the UK Treasury of 50p per £1 saved.
Meanwhile, the UK is now 18 months into AE implementation, a process that will continue until the smallest employers come into the fold in 2017/2018. Millions of people have already been auto-enrolled. The National Employment Savings Trust (Nest), which can be used by any employer to meet its AE requirements, is now used by over 5,000 employers and a million workers, a total expected to reach 3.5 million by 2018. Only around 7 per cent of eligible workers have opted out so far. “We’re going to see millions more people saving for their retirement and that’s very exciting,” says Nest chief executive Tim Jones.
Some fear that the cap on charges could put off some pension providers that might otherwise have developed offerings for this part of the market. Philp says he’s against the cap at an “instinctive” level, although he recognises the need to counteract a weak buy side.
But he is concerned that the cap might make it harder to understand charging structures. “I think the government should standardise the way pensions are paid for, then providers can compete on the basis of the quality of the product offering,” he suggests.
Just Retirement customer insight director Steve Lowe believes the system now in place should enable most workers to use the first two pillars to build up a retirement income to suit their needs. But, he adds, “if the guidance provided is no good we could have problems”.
“I think we will see a resurgence of interest in saving for retirement, given these new freedoms,” declares Gosden. “Hopefully the guidance people will get will help them to avoid making the wrong choices.”
Jones is even more optimistic: “I honestly think the UK has turned the corner in its pension provision.”
David Adams is a freelance journalist