Why the new world of pension freedom won’t solve the old problem of retirement income
There’s been a lot of talk about the ‘new world’ of pension freedom. But there’s nothing novel about what people need when they retire. Most require an income to replace their wage, just as they always have.
So-called pensions freedom is one of ex-Chancellor George Osborne’s great gifts to the nation. From 2015, no longer would most savers in defined contribution schemes (the kind in which the pension is dependent on payments in and market returns) have to buy an annuity, giving them an income for life. Instead, they could do what they wished with the money from age 55.
With one attention-grabbing announcement, he blew up the (flawed) old system, but failed to put anything in its place. The TUC and others warned that abandoning savers like this to a financial services market that is notoriously unresponsive to the needs of mass market savers was unwise.
Many would be ripped off. Others, in the absence of more obvious options, would simply cash their savings in. The ability of people to generate an income to see them through their later years could be hindered not improved.
There are growing signs that this is coming to pass, most recently in a report from the Financial Conduct Authority. The regulator found:
- Signs that cashing-in at least part of a pension long before retirement is becoming a cultural norm. The FCA report finds that 53 per cent of the pension pots that have been accessed have been fully cashed in.
- Charges for drawdown, a way of taking an income from a pension pot, are complex and opaque.
- There is little evidence of savers “shopping around” for retirement products. Some 94 per cent of non-advised drawdown sales are made to existing customers
- There are limited signs of innovation by product providers.
In short, there is evidence that the combination of product complexity and consumer inertia that led to so many people getting a poor deal from the annuity market has been replicated under pensions freedom.
These shortcomings are significant, not least because increasing numbers of retirees will be relying on DC savings in retirement. Putting in place measures to assist savers in meeting their retirement needs would underpin the achievements of automatic enrolment in bringing millions of low and middle income workers into the pensions system. But it is important that any changes draw on the experiences of past reforms.
The approaches mooted by the FCA fall into two categories: supply side changes that alter the way the pension industry runs and demand-side modifications that seek to empower the consumer so that market mechanisms change outcomes. These are not necessarily in conflict but we should be very clear about which are likely to deliver the desired results.
Recent pensions industry studies and reforms strongly suggest that the former should be emphasised. These include:
- The Office of Fair Trading’s 2013 defined contribution workplace pension market study found that competition alone cannot be relied upon to drive value for money due to the weakness of the consumer and complexity of products.
- Work done in 2014 for the FCA on the annuity market showed that despite various initiatives designed to encourage shopping around, almost half of buyers made their decisions with limited or no competitive information.
- The highly successful automatic enrolment reforms rolled out from 2012 have relied primarily on supply-side changes. Those who do not want to save into a pension have to actively opt-out. Employers are compelled to make contributions. There is a cap on charges on default funds. And the National Employment Savings Trust (NEST) was established as a back-stop provider to ensure that all firms and workers, however unattractive to traditional providers, could access a scheme.
Decision-making is very hard for DC savers as they approach retirement. Osborne’s pension freedoms want people to make assessments of their likely lifespan, investment returns and inflation outlook. And that they will continue to make these judgements throughout retirement.
In its response to the FCA report, the TUC has been clear that we believe the key to giving savers a better chance of good outcomes is the establishment of default retirement pathways. This is one of the options explored by the FCA. These would be well-researched, good value, securely governed solutions that would be suitable for most savers. In the TUC’s view, this would include a guaranteed income for life so those savings could never run out. Those who wished to pursue an alternative approach would be free to do so.
This would be a new world, but one rooted in the real world.