Written by Malcolm Small on Thursday 20 March 2014
The changes to the retirement income regime announced in the Budget represent the biggest reform to the UK’s private pension saving architecture, certainly since Defined Contribution (DC) pension schemes began to be widely adopted in the early 1970s. It’s been clear to us from our research base that the effective requirement to buy an annuity with your pension “pot” at retirement was widely regarded as one of the most unattractive features of the DC pension regime, and that it was becoming an active disincentive to engage with pension saving. Recent reforms to introduce “flexible” income drawdown helped, but did not go far enough, requiring a “base” income of £20,000 per annum to be secured before the rest of the fund could be accessed. The rules around “fixed” drawdown were also too restrictive, with a 120% of annuity limit on what could be drawn.
Now, subject to consultation and legislation, all this is to be swept away, representing a very liberal reform. For too long, we have patronised people by telling them what they can do with their own money, the retirement “pot” they have built up. At long last, people will be able to access their retirement savings at any time, and in any amount, subject to tax as is the case today. The consultation document is available now, and we’ll take a longer look at that shortly.
A new ISA – the “NISA” – was also announced, although this is simply a sensible liberalisation and amplification of the existing regime, increasing the investment limits to £15000 and allowing much more flexibility in the cash/stocks and shares mix. Peer-to-peer lending products will become ISA eligible, and government will consider allowing debt securities issued by “crowd funding” entities to be held. All this is also good news.
Returning to pensions, consideration of the consultation document lets us look in more detail at some of the other measures to be brought in around these reforms, and their possible impacts.
To help people navigate the new landscape and make good choices about what to do, government is proposing that a duty be placed on pension providers and trust-based pension schemes to provide “Guidance” on the options in front of an intending retiree at retirement age. This is expected to be in place by April 2015, which I would consider extremely ambitious, given the glacial pace at which the pensions industry moves, and its fragmented nature. I would expect much of this “guidance” to be outsourced to third-party firms, but it will be a massive job, with at least 8000 retirees a week, or 1600 a day, needing this guidance! Government intends to “work with FCA” on making any actual regulated “advice” delivered after the “guidance” to be delivered more cost-effectively, and possibly on line. My experience in this area suggests this could be a minefield, with the boundary between “guidance” and “advice” having proved extremely difficult to define in previous attempts to do so. And although there will be £20m made available by government to get this going, it will be an additional, and unexpected, cost to pension providers and schemes in the long game, one which providers of schemes for automatic enrolment, for example, will not have factored into their business plans.
A little-noticed measure is that the Minimum Pension Age, the lowest age at which any pension benefit can be drawn for those in good health, will rise to 57 in 2028, the year in which State Pension Age (SPA) will rise to 67. This is to preserve the 10 year differential with SPA which we have today.
The effects of the reforms to the retirement income regime for DC on the Defined Benefit (DB) pensions, available in the public sector and the private sector today, are considered at some length, and rightly so.. The former are largely, although not wholly, unfunded and government is clear in that it will not allow transfers from such schemes, as being detrimental to the public interest. It is less clear about funded public sector schemes, such as local authority pensions. It sets out a range of options for private sector DB, from a ban on transfers altogether, to allowing all transfers to DC schemes, which, subject to advice, is the position today, and which is government’s broadly preferred position. There are many potential unintended consequences for DB schemes here, and with £1.1 trillion of assets invested in them still, the effects could be dramatic if we get implementation wrong.
Government expresses the view in the consultation that most retirees in DB schemes would stay with them at retirement, and not transfer to a DC scheme at that point, to benefit from the new flexibilities. I disagree. I think that it would be very hard to argue that a DB retiree should do anything other than transfer at retirement, given the attractiveness and flexibility of the new regime, although I’d anticipate a lot of debate here. If we did see such an effect, the implications for cash flows and current investment strategies in DB schemes could be severe, but it would require a big retreat from the current position, which is to entitle everyone to a transfer.
But what is certain is that these measures will have a big impact on the market for annuities. The consultation expresses the pious belief that annuities will still be a good choice for many people, providing certainty of income in an uncertain world. Whilst this may possibly be the case, there is no doubt that the annuity market we have today will shrink, possibly radically. I would expect that the people who might buy an annuity going forward would be more modest savers, who want certainty of income and do not want to deal with investment risk, or those needing an immediate needs annuity for care home fees, perhaps. There remains an economic argument for those in their 80s to buy an annuity, given the rates available to them at that age. The annuity market will also shrink at the bottom end, with the “trivial commutation” limit, where the whole fund can be taken as cash, rising from £18000 to £30000. This will mean that more smaller “pots” are taken as cash than is the case today, taking many more out of the annuity market.
However, I think the reforms announced in the Budget around retirement income make pension saving radically more attractive than it was before, and makes pensions much more responsive to the circumstances older people find themselves in today. This is especially true for the people we are automatically enrolling into pension saving, who will not now be automatically placed into an annuity, and may be able to get good value from pension saving in a way they could not do before.
These reforms have been a long time coming, but they are very welcome.