Q&A: Pension freedoms - what does the future hold?
When we wake up on April 6th we’ll be faced with a new dawn in relation to what people can do with their Defined Contribution (DC) pension savings. So what does this new “pension freedom” mean for you? We asked John Leavey, Head of Corporate Benefits at Benefex what he thinks…
So what exactly is happening?
Well, for the first time people can, in theory, take all their pension savings built up in their Defined Contribution (DC) funds as a cash lump sum. This was announced in last year’s budget with much trumpeting by the Pensions Minister that pensioners should be free to buy a Lamborghini if they choose.
What are the implications of this?
No longer will people be obliged to buy an annuity when they retire and although this obligation had technically been removed previously, the level of flexibility we are now faced with was certainly not there before.
What might the future hold for those who are still saving for retirement and also those who will be facing complete freedom with what to do with their savings? Will the Lamborghini showrooms be open late to cope with demand?
For the answers to this, and other questions, we firstly need to examine whether the providers who are tasked with administering the new flexibility are ready with systems and processes that will accommodate the expected demand for cash payments. A simple answer here is that, in the main, they aren’t. Coming at a time when other issues have caused upheaval in the pension world (such as the introduction of a charging cap and the continued roll-out of auto-enrolment) the timing of this probably couldn’t have been worse for providers.
When someone who has held off accessing their pension until April comes knocking they will, quite rightly, expect a seamless process to facilitate their wishes. Although we have a brief period to go before April, the outlook does not look promising that everything will be in place across all providers. The likelihood of frustration and anger across a proportion of the population is inevitable, and certainly the perception that people can treat their pension scheme like a cashpoint is a long way from reality.
On the assumption that all this has to work properly at some point – what is the likelihood that people, having saved diligently across their working lifetime for their retirement years, will blow all their savings on new cars and cruises, and run out of money?
In all honesty, we don’t know. Although there are statistics available from other countries where they operate a similar model, we simply don’t know whether these will be replicated in the UK. Plus it will take up to a few years, once the initial wave of those who have deferred accessing their pensions has gone, before we establish what the true pattern of encashment looks like.
But we do have to assume that the numbers of people who will take an annuity in the future will be significantly lower – so what are the implications for this?
Well, the first major issue is that people generally underestimate how long they are going to live, so even if their chosen approach has been considered carefully, are we going to have retirees who run out of money precisely at the point when their ability to earn a living has significantly reduced? The answer in a number of cases is probably yes.
So what does all this mean?
The knock on impact of this is potentially significant in two main areas; both for the individuals themselves in terms of lifestyle but also for younger people who may find less access to the workplace as older people have to continue working and potentially block access to jobs.
There are also other less obvious issues which lurk quietly around the corner. For those who are entitled to means tested state benefits having their money sitting in a pension scheme had no impact on these benefits. If the withdrawal of pension savings as a cash sum is too great then this could potentially be viewed by the Department for Work & Pensions as an asset, affecting the claiming of such benefits. Additionally, some people who take the cash may find themselves inadvertently slipping into a higher tax threshold as up to 75% of any cash withdrawal will be treated as income, added to the individual’s earnings and taxed accordingly.
Has all the excitement around new found flexibility turned to doom and gloom?
Far from it – but we should remember that a significant proportion of the population are challenged by financial matters and they will need help to make the right decision.
It was not insignificant that at the same time as the new freedoms were being announced; the Chancellor also revealed that everyone approaching retirement would be offered access to a free guidance facility to help them understand their options.
Will this service provide comprehensive information?
Much debate has centered on the quality and accessibility of the ‘Pension Wise’ service provided by the Citizens Advice Bureau and the Pensions Advisory Service. What is clear is that this service will only go so far in terms of the information they can provide and unquestionably there will be those left waiting for answers to the questions they don’t even know they should be asking. Access to Independent Financial Advisers will still be an option, but historically this has been a route taken by only a few, with no indication of this being any different in the future.
Where does this leave employers who feel that their workforce may need some help with these life changing decisions?
When it comes to DC pensions you will need to examine how your current arrangement deals with its default investment fund. For many schemes, the default investment fund is established on what is known as a lifestyle basis which, in broad terms, is designed to move to safer investments as people approach a target retirement age - with an ultimate investment mix designed to mirror the purchase of an annuity. With many people no longer choosing to buy an annuity these funds need re-assessing to ensure they are fit for purpose. The investment industry has much work to do in this area and the current thinking that Target Dated funds may be the current answer to this issue has yet to be tested in the longer term.
What does the crystal ball indicate for the future?
Political input is likely to continue into pensions with several parties looking to change the level of tax relief available on contributions following the forthcoming General Election. Regardless, it is vital that DC pension arrangements are reviewed as soon as possible to ensure they are fit for purpose in the new environment. The history of changes of this type haven’t always turned out the way that was expected at the time of their introductions and it will be important to ensure that employees are made aware of the need to look to the fundamental reason for them having a pension in the first place, namely maintaining an income and comfort into their old age no matter how long they live.
What does this mean for annuities?
It is likely that annuities as we know them will undergo some kind of rebranding as the very name invokes distrust in many. Clearly the attraction of cash will be popular for many – albeit most of it taxed – but people do fundamentally require an income stream in retirement. Annuities (or whatever they become known as) still have their place but it may be that instead of going straight into these at retirement the purchase happens at a later date with some kind of income drawdown occurring prior to this point.
What does the future hold for car salespeople?
It is possible that some car salespeople may well be seeing an upturn in their commission in a few weeks, but if we can educate employees better hopefully a balance can be struck.