The Budget one week on – what does it mean for retirement?

John Leavey

Categories: Reward and Benefits

The budget of March 2014 will go down in history as the one that re-wrote the future of retirement saving. These surprising changes to the way pension savings work should not only prove popular with the voters, but also mean a whole cultural shift in how employees view pensions.

We’ve spent the week discussing the key points and have only been left more convinced of the need of financial education (something that we’ve been delivering for a while now). Although the Government have announced that defined contribution members will receive free face to face guidance at retirement, the need to educate people on financial matters becomes sharply focused from now on, as leaving this to retirement could well be too late to develop a sensible strategy.

Below you’ll find our thoughts on 5 aspects of the recent Budget announcement. We’ve left out the part about beer and bingo, but focused on what the changes will mean when it comes to retirement. You’ll notice that we have many unanswered questions. We’re open to debating these.

Here’s one to get you started: Given the continued march of auto-enrolment and the increase to the ISA limits, does the government need to continue to “incentivise to save” through the payment of higher rate tax relief? We’d say only time will tell, but as of now there is a great argument for savings in pensions to become popular, due to the tax reliefs given and the new flexibility on drawing the value from these.

This new found freedom does bring to the forefront aspects which historically might have only been considered a “nice to have” (we’re talking about financial education and retirement guidance). Given the removal of said historic restrictions, do you think this will lead to pensions becoming popular? We shall see…

Budget element 1: The ability to take all defined contribution savings as a lump sum

Previously any drawing of a pension in the form of cash in excess of the tax free cash (or pension commencement lump sum as it is strictly known) would have been subject to a penal charge of 55%. From April 2015 it is proposed that this amount will be at the employee’s marginal rate of tax – essentially permitting the taking of the whole pension pot as a one off lump sum. This, coupled with the removal of the requirement to take an annuity, re-writes the landscape for pensions.

This change is a game changing deviation from the previous principles of pension saving in the UK where it was primarily about tying people into a regular income generating process.

What do we think?
Well, to be honest, this one change throws up many questions, many of which are unanswered:
What will people do at retirement? If they take the whole value as a cash sum will they spend a huge portion on holidays and cars and create the issue that at some future point they will run out of money? People generally underestimate life expectancy and income requirements so how will they manage this new found freedom?

If they do choose to buy an annuity – and for some this will remain a sensible choice - what are these going to look like in terms of value? Although it is generally accepted that the market for annuities will significantly fall – potentially by about 2/3rd from its current levels, opinion is divided as to whether this will produce better or worse terms.

A significant number of default investment funds for defined contribution (DC) schemes are written on a “lifestyle” basis – principally around the assumption that the vast majority of members will end up in an annuity upon retirement. With this no longer being the case what does the future DC default fund look like? Will this make Target Dated funds more popular?

And then there’s auto-enrolment. With the ability to take the full pot as a cash sum are there that many valid reasons left that mean people should opt-out of being auto enrolled?

Will this move encourage people into the buy to let market – creating its own potential issues? People have long been in love with property as an asset class and the freeing up of pension cash will surely feed this market.

Budget element 2: Financial guidance at retirement

The Government announced that from April 2015 all defined contribution scheme members would be offered access to free face to face guidance at retirement. They have backed this with a development fund of up to £20 million. The long term funding is expected to be met by a levy on the pension providers.

What do we think?
This is one of the great unanswered questions in terms of how this might be delivered. It is a huge logistical challenge set against a backdrop of falling adviser numbers. It is significant that the term used is “guidance” rather than “advice” but nonetheless this will be a huge task to implement and deliver – especially in the timeframes outlined.

The main options available are to have this driven by providers – which comes with its own concerns around impartiality – or through some kind of independent source such as the Money Advice Service or The Pensions Advisory Service (TPAS) – but the resources required for this are huge and are a long way from being readily available. This will be an interesting one to watch its development.

Budget element 3: Pensioner Savings Bonds

From April 2015 National Savings & Investments will launch a range of fixed range savings bonds for those age 65 or over.

What do we think?
The rates currently anticipated for these bonds are 2.8% gross for a one year bond or 4% gross for a three year bond although there will be a limit of £10,000 per bond. In light of the wider changes these may prove popular for those seeking a short term haven for their pension cash.

Budget element 4: Removal of the restriction on tax relief on pension contributions beyond age 75

Previously any contributions that attracted tax relief needed to be paid in before the age of 75. From 6th April 2015 this restriction will be removed.

What do we think?
Given the on-going trend of people working later in life it is a sensible step to remove an obvious anomaly in the system – particularly in light of the other changes.

Budget element 5: Increase in the minimum pension age

The Government are proposing that the minimum age at which you can draw a private pension be increased from its current minimum of age 55 to age 57 and will also rise in line with future increases in the state pension age.

What do we think?
Given the rise in state pension age this is an inevitable step that will see the minimum age being 10 years below the state pension age.

You can find out more about what we think of the Budget and other important topics by downloading our fact sheet here.

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