It’s official…no more compulsory annuities, says the Chancellor
22 March 2014
The Budget announcement was monumental for the pensions industry this time around. Frankly the changes made Steve Webb’s initiatives to improve the effectiveness of the annuities market in the latest Thematic Review look like mere tinkering.
Osborne declared that from 27 March 2014 anyone of pension age (over 55 years old) will be able to draw as much of their pension pot as they choose at any time. One quarter remains tax free and the balance will be taxed as income at the marginal rate (generally 20%) as it taken. The Treasury’s coffers should be filling at least.
The Guardian took a gloomy view of what would happen as a result of this move to liberalise pension decision-making. Based on research into Australian experience, where annuity purchase is also now voluntary, the message came through loud and clear – we’ll blow most of our retirement funds within minutes of laying our hands on it.
According to the Challenger Retirement Income Research, Australia, dated April 2012, only 4% purchase an annuity at-retirement in an average year. 32% instead buy a home, pay off a mortgage or make home improvements; while 19% buy a car or pay off a car loan. More positively, 21% kept it invested in a pension scheme.
PwC believes that some 70% of UK pensioners will choose to take the cash and Barclays Equity Research predicted that the £12bn a year market for annuities could be reduced by two-thirds – falling to just £4bn within the next 18 months. Dramatic stuff indeed if all of this comes to pass.
So-called ‘trivial commutation’ limits which allowed smaller pension pots to be cashed in after retirement age, will rise significantly from £2,000 to £10,000 and those who have retirement savings in multiple pension pots will be able to take out a maximum of £30,000 up from £18,000 maximum before. Average pension pot values are well below £30,000 today. As one article in the FT recently pointed out, pensioners with less than £20,000 are particularly heavily exposed to poor annuity values. Now these vulnerable pensioners will have options between taking the cash, going with income drawdown or an annuity purchase (or a mixture of all three).
Income drawdown limits are also being relaxed so that the minimum annual income requirement for flexible drawdown nearly halves from £20,000 to £12,000 while the maximum income a person in income drawdown can take will rise from 120% to 150% of GAD. Again the message is loud and clear – let pensioners make these grown-up decisions about how much income they think they can afford to take out of their pension savings.
Simultaneously annual ISA limits are being pushed higher still, rising by £3,480 to £15,000 and the NS&I will be unveiling a new pensioner bond (2-year fixed rate bond) for those aged over 65. It has a limit of £10bn worth of savings for this product.
Clearly the move is very negative for the annuity market which has been under attack for some time (and the Pensions Minister is not finished yet). But what does it mean for pensioners who now have to think much harder about what to do with their retirement savings? It is well known their financial capability decreases as we get older. At least with an annuity you know exactly what you are getting until you die. In the new post-compulsory annuity world (from April 2015) it will be more difficult to assess what income you really have and many will undoubtedly over-spend, leaving themselves short as they get older and more vulnerable.
Anticipating this argument, the Treasury has made £20m available to help providers give financial guidance to pensioners as they make their decisions. Our view is that this money will barely touch the sides as the risk of miss-selling at-retirement falls firmly at the provider’s door at a time when the complexity of decision-making has just increased massively. Simultaneously, providers will have to consider the cost of administrating different income options and will need to work harder to understand their clients in order to ensure they are giving suitable guidance.
They will have to engage clients to make informed decisions while ensuring they fully understand the implications of those decisions. This is serious stuff as mass, legalised pensions liberation could also lead to mass destitution in a few years from now if retirees make the wrong decisions.
If you do not have a libertarian bent then there are real concerns about going down this road. For example, family pressure could force pensioners to spend more of their retirement income on helping out hard-pressed younger family members than an annuity would have allowed. Women, who already have smaller pension pots than men on average, are more vulnerable as regards this simply because they are more prone to help out family members.
What is clear if we are putting more responsibility on the individual to manage his or her financial affairs sensibly and carefully right through into their dotage; then it’s going to be critical to educate them better on financial matters - long before they reach retirement.
What’s your view was the Chancellor right to set pensioners free by scrapping compulsory annuities, increasing trivial commutations and income drawdown limits substantially? Or is this move to liberate pensions one that society will pay for in a few years from now and long after George Osborne has left Number 11?