From Ros Altmann:economist and pensions,
    investment and retirement policy expert

  • pensionsandsavings.com

    Pension freedoms carry risks but are better than the old system

    Pension freedoms carry risks but are better than the old system

    • FCA concerns about ‘significant risks of harm’ from pension freedoms are valid, but do not mean freedoms are wrong.
    • Consumers are facing new risks, but it is right to allow people to manage their pensions over time, rather than requiring most to just buy a standard annuity. 
    • Original policy intention of ensuring everyone receives impartial guidance or advice before taking money from their pension was absolutely right, but this is not happening in practice. 
    • Without impartial guidance or advice, consumers are at the mercy of providers and scammers, without the necessary information or experience to make good decisions. 
    • The more people who receive PensionWise guidance the better,
      to help avoid scams and make better use of hard-earned pension savings, rather than just calling provider helplines.

    It is certainly true that there are significant risks for consumers as a result of the new pension freedoms. But this does not mean that the policy itself is wrong. The problem lies more with the way the market has developed, the difficulties faced by consumers in understanding how pensions work, the complexity of past products and the lack of financial education among the population.

    It should not be forgotten that there were serious risks for consumers under the old regime too.

    The original intention was that people would receive free, impartial guidance to help them with their pension decisions:   The Government was absolutely right to trust people to make their own decisions about what is best for them and decide what they want to do with their pension funds. But a major problem is that so many people are being left to deal with the new freedoms without any financial guidance or advice. The Government’s original intention was also to ensure that everyone would receive free, impartial, expert guidance before they made their decisions – and ideally would receive independent, impartial financial advice.

    The Government went to enormous lengths to establish the PensionWise guidance service: PensionWise has done an excellent job for those who have used it. It has helped them understand the risks and important issues they need to consider before making irreversible pension decisions. Those who use the PensionWise service will make better-informed decisions and have a chance to understand the implications of taking money out too soon, how much tax they may pay, the importance of long-term planning and the complexity of pensions. They may then realise why they might want to use an independent adviser to help them through the complex choices.

    PensionWise has saved many people from losing money to fraudsters: People who have an appointment with a PensionWise guider will be more likely to avoid falling for scams. If they are about to transfer their pension as a result of a cold-call, then PensionWise can warn them about such criminals. Sadly, take up of PensionWise has been woefully low, around 90% of people are not receiving any help.

    The Government also introduced a new £500 ‘advice allowance’ to encourage more consumers to use an IFA: For the first time, the pension freedoms have resulted in official recognition of the importance of using an Independent Financial Adviser and the value of paying for independent, expert financial advice. It introduced the ability for people to take £500 out of their pensions to pay an adviser to help them making important pension decisions. Unfortunately, take-up of this allowance has also been almost non-existent, with most people unaware of it and pension schemes failing to promote it – or in some cases not permitting it at all.

    The vast majority of people are making pension decisions on their own: This was not the intention of the original policy and clearly increases risks to consumers. The lack of guidance or advice has caused many to make poor choices or even to lose their entire pension. Pension providers clearly have unfair advantages over their customers, due to the complexity of pensions and the asymmetry of both understanding and experience.

    Consumers are too often relying on their pension provider helpline which is not impartial: Many customers are making decisions to take money from their pension without realising the consequences, or are just using their pension provider’s helpline to buy whatever products they can offer. Taking cash from their fund when they are in their late 50s or early 60s, without realising they will lose 40% or 45% of this in tax, is not a sensible strategy unless the money is put to better use. Most people will be better advised to preserve their pension money for their 80s and beyond.

    People need help to understand the tax benefits of keeping pensions longer: To make the system work better for individuals, we need to ensure more people (ideally everyone considering taking money out of their pension) use the free PensionWise guidance service, and as many as possible have the help of expert, reputable, independent advisers. The tax advantages of pensions are significant and many people are withdrawing funds from pensions and paying much of the money in tax, rather than leaving their fund untouched. Even if the market falls 30%, if withdrawals are taxed at 40% or 45%, then the consumer could still be better off leaving the money in their pension for later life.

    Most people who are still working should keep the money in their pension fund: Those who have not yet retired are unlikely to need to cash in their pension fund. If they are still in their 60s, they should have a 20 or 30 year time horizon and taking the money out means losing the tax benefits of pensions (the income and growth are tax free and any money passed on at death is tax-free too). Leaving the pension gives time for the fund to grow in future. Pensions are meant to support you when you no longer work, rather than provide spending money in your 50s and 60s. These are the important messages that financial guidance can help with.

    New approaches could include considering pension in four parts – for your 60s, 70s, 80s, 90s: Pension providers have not really developed exciting new products or approaches to replace the old choice between just a standard annuity, or drawdown. Nowadays, fewer people are buying annuities, but the alternative is usually just a drawdown fund, which charges higher fees than pensions. There are some basic new ideas that could be developed to help people manage their pensions through their retirement. For example, if people’s pension funds are divided into four parts, then those who are reaching their 60s could have one quarter allocated for the short term (if needed), one quarter for spending when they reach their 70s, another quarter invested for their 80s and a quarter designed to spend in their 90s. Over time, these funds can be revisited and, if someone is still working, they may not need the first 25%, so could keep that to supplement spending in the years when they are retired.

    Freedom is much better than the old system but consumers need help to make good choices: The pension freedoms were a golden opportunity to help people achieve much better outcomes than under the old system. In my view, it was wrong to force almost everyone to buy an irreversible product which might not be suitable for them, which they did not understand, which had become poorer and poorer value and which often made no provision for a partner, or for those in poor health. Trusting people with their own money makes good sense, as long as they understand the choices facing them and are not just at the mercy of providers. The asymmetry of information and experience creates risks, which is why we need to encourage more use of guidance and advice as quickly as possible. Let’s not abandon the freedoms, let’s make their work better.

    4 thoughts on “Pension freedoms carry risks but are better than the old system

    1. This all makes sense Ros however as we know unless you make it very clear and simple people will switch off until they need money and then panic.
      I like the 4 pot idea but I prefer the 3 phases of retirement which I guess is a similar concept.
      1. ACTIVE – this is the time to enjoy your health and do the things that working stopped you from doing. You may need a little more money during this phase
      2. PASSIVE – this is when you slow down a bit and maybe dont have the same energy or health. You may need less money at this point.
      3. CARE – This may be in ones own home or in a care home. This may need more or less money depending on ones other assets and needs and the local authorities rules if the care home is state run.
      At the same time the interaction between a couple could make this more complicated SO having the flexibility is paramount.

    2. Dear Ros, The whole policy of pushing responsibility onto the individual to make complex decisions with respect to their pensions, with potentially huge financial consequences, is wrong. The vast majority of the population are not equipped to make such decisions and I have little confidence in IFA’s based on my own experience. At present, a good proporation of existing retired persons are still beneficiaries of defined benefit schemes, which will pay a pension for the remaining lifetime of the scheme member, and often also to a surviving spouse. Those pensioners are very fortunate. Unfortunately, this will change dramatically over the coming years and I fear we will witness large numbers of pensioners living in abject poverty as their defined contribution funds run out, and they find that the basic state pension is wholly insufficient to live on. It doesn’t have to be this way. Ros, if you have not already seen them, I recommend you review some of the Retirement video series on RealVision.com or on uTube. While these also address pension issues in the USA as well as the UK, the underlying problems and potential solutions are very similar. In particular, you should watch an interview with Jim Keohane, CEO of the Healthworkers of Ontario Pension Plan, entitled “Managing $80 billion worth of Risk” in which he describes how that plan has avoided the issue of companies not wishing to have the liabilities of defined benefit schemes on their books, yet has been able to provide secure pensions to members of around 70% of their final salary, based upon an 8% contribution from their pay packet throughout their careers. The members of that scheme are fortunate indeed to be in a collective plan which spreads many of the risks, can leverage investment techniques not available to individuals, can employ professional money managers (their own employees, not farmed out to some Wall St firm only interested in earning high fees) and incur far lower costs as a percentage of funds under management than an individual. In addition to these many benefits, and the peace of mind that these pensioners have that their pension cheque will arrive each month as long as they live, Mr Keohane also points out that their spending habits are completely different to those pensioners uncertain whether their funds will last their lifetime. They continue to be consumers supporting the economy, rather than scrimping and saving through the worry of outlving their pension pot. I fear that such a change of direction in the UK with respect to pension provision is almost impossible, but we are going to witness far more pensioner poverty, and all the associated problems and sadness, in the coming years. In my opinion, it has been complete madness to fragment on an individual basis the attempted provision of secure pensions. This is an activivity far more effeicently and effectively carried out for a large group of people together with the goal of emulating the “old style” defined benefit schemes. I think the Ontario Healthworkers plan is a template of how this can and should be done.

    3. One huge advantage of the freedoms is for those many people with small pension savings who also need means tested state support. The old compulsory annuitisation saw a penny for penny reduction in benefits, often leaving them with no real income increase at all.
      Now, if properly informed, they can draw down small amounts as capital without affecting their benefits.
      The new problem is getting informed. This needs some personalised assessment. PensionWise hasn’t been allowed to do those sums and financial advisers are both too expensive and not knowledgeable in that area.

    4. Hi Ros, interesting thoughts, I favour encouraging more people to save earlier for retirement, Evan from being babies. The government could give each new born £1000 to be invested in a sipp, the likes of HL, AJ Bell etc could tender for this business and government could negotiate lower charges with them. There could then be voluntary or auto enrolment system for parents /grandparents to pay in monthly or as and when. These payments would be subject to tax relief (as now) and concessions against much despised inheritance tax for older contributors. Given the timescale, the investments could be fairly adventurous and the timescale would also iron out volatility in markets.
      In adult life things would not change, auto-enrolment and workplace pensions would add to pot, the choices at retirement would not change either.
      Growth of 7% a year would produce a good pot at 60-65.
      This way everyone would have their own pot and eventually state pensions could be abolished and reliance on the tax payer to fund expensive public sector pensions could be significantly reduced.
      Something to think about for a long term solution

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