George Osborne’s announcement that people with defined contribution (money purchase) pensions could take the lot as a lump sum on retirement kills several birds with one stone. First, it most definitely attracts the grey vote because the idea of getting your hands on your whole pension pot on retirement is very appealing.
But this also looks like a reaction to mounting evidence, including from the Financial Conduct Authority no less, that annuities are not good value for money. Defined Contribution schemes allow retirees to buy an annuity (your pension) on the open market, but the schemes provide a default annuity which most people end up with because they are too nervous or don’t feel they understand the issue well enough to shop around. The FCA says that companies make vast profits out of providing the default option because of the captive audience. As co-chair of the Association of Member Nominated Trustees I was suggesting recently that perhaps pension schemes ought to stop providing the default option if it’s ripping consumers off, and instead provide access to a simple to use online annuity selection tool in addition to an adviser.
So the announcement could also be seen as a slap in the face for the insurance companies who have failed to provide a product that was fair to the consumer. Also it has been quite a worry for the DWP that having set up pensions autoenrolment, getting millions of people to put their money into pension schemes, when these millions retire they might end up with poor quality pensions as a result of annuity rates and costs. Telling people they can take the lot as a lump sum is one way to solve this problem.
Except that by doing this it potentially sets up a much bigger problem. People can retire in their mid sixties and live another 30 years. How many are going to take all their pension savings out and eke it out for as long as that? They are gambling that they won’t live that long. Others, perhaps those on lower incomes who are short of cash anyway and have quite a small pension pot, may just spend the money on paying off the mortgage, paying bills or buying a new car. Data from countries such as Australia indicates that when people have the option of taking the lot, only 4% buy an annuity. Those with larger pots buy property to let and live on the income, which in the UK will only inflate house prices further.
Pensions were dreamed up centuries ago as a way to ensure that when people became too old to work they wouldn’t end up starving in hovels. You put your money in when you were working and then were paid it as a regular income when you retired. If people are given the option of taking the lot then some are going to see the jam today and forget about how they are going to live over the next 20 years. You might say that’s their decision, and indeed the government is blithely unconcerned about people blowing it all on a Lambo – but eventually it could become a big problem for government as it could undermine the whole purpose of autoenrolment.
So in the long run this announcement could negate the whole point of pension saving – that people will have enough to live on when they retire – and leave millions once again relying on the state pension as their sole means of survival in old age.
The big problem that this does nothing to solve is the poor quality of DC scheme design that we inherited from Margaret Thatcher and which Labour did nothing to improve.
The proper solution is to pursue SLF, Lib Dem and Steve Webb’s policy of bringing in a new type of pension – defined ambition. I believe this should be Collective Defined Contribution which provides a simpler, more cost-effective and reliable pension which avoids buying annuities by paying your pension direct from the scheme. Perhaps when the pensions industry has absorbed this week’s shock announcement it might make them more amenable to such change.
* Janice Turner is Vice Chair of the Liberal Democrat Campaign for Racial Equality
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40k – a typical pension pot – would buy a Mercedes A class. After tax £40k reduces to about £25k; maybe a Volkswagen Golf. It’s hardly motoring beyond the dreams of avarice, is it.
If the prediction of buy-to-let being a popular destination for larger pension pots holds true it has another unpleasant side effect: yet more inheritance. Whereas an annuity ends with the death of the beneficiaries, a house can be passed on to the next generation as an asset increasing the unmeritocratic propagation of wealth between generations further.
It’s all very well giving people freedom but they have had all manner of tax breaks because they were saving for a pension. If you make these changes the effect is that it basically becomes a bond that you can’t touch until you’re 65(66?). What bothers me is that it looks like the government is no longer encouraging personal responsibility but simply looking for cunning ways to give the better off tax cuts by the back door.
Well yes people might spend their own money unwisely or make decisions which in retrospect seem unwise
But isn’t that their choice? Indeed I am not sure why you thing that choosing to take the pension pot and pay off a mortgage is unwise – in lots of circumstances it may be totally logical.
It is not clear to me what how a Collective Defined Contribution works. The piece says this: ” provides a simpler, more cost-effective and reliable pension which avoids buying annuities by paying your pension direct from the scheme.”. There is nothing to stop people doing this via ‘draw down’ – but the key issue of how long people expect to live and therefore how quickly they should draw down the pension pot still remains.
“People might spend their own money unwisely or make decisions which in retrospect seem unwise. But isn’t that their choice?”
Well, not if the State has subsidised your pension pot using other people’s money, on the understanding that you would use it to draw a pension.
If instead you invest a lump sum and draw it down at a rate you decide for yourself, you’re gambling that you won’t run out before you die. If you live long, you may lose that bet and run out of money. Given that most people haven’t saved enough, there will be lots of people who lose that bet. They will be the people who kidded themselves that the reason the annuity option offered them so little to live on was because evil annuity providers were swallowing huge profits. Not so. The annuity providers basically tell you how pitifully little you have in your pot, and how best to trick it out. Those who don’t believe them, and spend faster, will be riding for a fall.
What will these noble self-reliant people do, when the Lamborgini wears out or their pot runs out? Will they say, as Webb suggested, that well, they had their choice, they did it their way, and now they will be philosophical and happily starve to death? The hell they will. They will say “There are lots of us. We all vote. We have grey power. That State which we slagged off in out boastful right-wing way when we chose to blow our pension pots – Well, we’re going to force the State to bail us out again. With the money they can extract from the prudent.
Hi Janice, thanks for the article, but I disagree with part of it. A Lib Dem solution can include more regulation, but it must also include the recognition that annuity prices will almost certainly fall when interest rates rise. If people hit the industry very hard now they will annihilate it once interest rates rise, which cannot be a Lib Dem proposition.
Best wishes
Following on from my previous post: you also make some recommendations for the advice process. Part of the state has been trying to do a power grab over the financial advice industry with the Money Advice Service. We have been fighting it, sometimes successfully and sometimes not, and being a Lib Dem kind of guy I don’t mind letting go a bit of power, but my patience with the state, quango or mutual is best power grab is limited. 🙂
No, it looks like a way to get people to spend more, which is thought to be needed to help the economy recover. Forget the long-term effects, we’ve still got to manage the short-term emergency.
Experience has taught me that whenever the Tories (and now the Lib Dems) start meddling and interfering in people’s pensions it always ends in disaster cf Thatcher’s de-regulation of pensions provision and the great mis-selling scandal. The pensions industry are already planning new financial products that will be more appealing than annuities. To achieve that they will have to offer far more attractive but optimistic rates of return. And if the returns are artificially inflated we may witness another variation on the endowment mortgage fiasco that has meant people can’t pay off their mortgages. We might even see a crash in the pensions sector. Despite the glee of the Tory press I think that the coalition will find that there is very little political advantage to be had at the next general election from Osborne’s attempt to bribe people with their own money. For a start, there are millions who, until now, have been forced to purchase annuities that they didn’t want and are now hugely resentful that they will not benefit from the opportunity to get their hands on their entire pension pots. It seems to me that by the introduction of this anti-business measure the Tories may have angered a lot of their core vote.
I also have to bring out this half-false statement: “They are gambling that they won’t live that long.”. The industry, out of self-interest, has been strongly encouraging people not to start spending all their investments on things like fast cars for years and to just live off the interest instead. Why don’t these people also get a mention?
Regards
CDC are one of a number of ways in which individuals could choose to provide income for themselves, the operative word being choose, perhaps with a little nudge, but no more.
Annuities primarily invest in fixed income securities such as long-dated corporate bonds and gilts. Let us take as an example the current “best RPI-linked annuity” on the Hargreaves Lansdown website.
For a 65 year old living in an “average postcode” the best (not the average or the worst) annuity offers single-life RPI -linked income of £3534 per annum for £100,000. Now given that the average pension pot is £25,000 this will buy a 65 year old an index-linked pension of about £900 per annum – which is £300 less than the annual road fund licence for a Lamborghini.
If the annuity is invested into index-linked gilts then we can use simple arithmetic to calculate that a £100K pot will be exhausted after about 28 years – i.e. at age 93. So if “on average” annuity holders die before age 93 then the provider of the best annuity will make a profit. For the record the average life expectancy in this country is 81, so the provider will on average keep43% of the principal.
In the absence of competition the annuities industry has grown fat and lazy. I think it would be wrong to categorize it as a cartel: it is just “cartel-like”. As I said previously, I will be delighted to consider an annuity as an option for my pension alongside the alternatives that were previously denied to me.
Will there be problems with the changes to the system? Of course there will be. There will be press stories about little old ladies forced to hand over their pensions by their greedy offspring. There will be scammers coming out of the woodwork and stories on Watchdog. There will a few people who have a delayed mid-life crisis and actually do buy a Lamborghini.
But will it make saving for retirement more attractive than when the only option was an annuity with a typical total return of only 57% of the invested amount and the rest going as bonuses to the lads? Yes.
@Janice Turner
“Those with larger pots buy property to let and live on the income, which in the UK will only inflate house prices further.”
Lots of people say that it will inflate house prices, but without explaining why. I’m not at all convinced.
The first simple point is that the customer is no longer forced to buy an annuity, so the industry will have to give up ripping off pensioners (or find another way) I agree with Paul in Twickenham. Second point, this change comes in at about the time the basic, non means tested pension comes into force. This means people will know what their basic income will be and can add to that if they wish to. Buy to let will increase the number of properties for rent and so will put downward pressure on rents as well as putting upward pressure on house prices.
Well of course nobody really knows what the long term effects of this policy will be, but doesnt the waywith which it has been hyped up in most sections of the press rather remind one of the glee with which council house sales were greeted many years ago – the soundbites are very similar… talk of individuals gaining, freedom. increased wealth etc etc. etc…. look where they has left us years later – I fear that in years to come we could well be looking back and wishing we could turn the clock back.
“It looks like a way to get people to spend more, which is thought to be needed to help the economy recover. Forget the long-term effects, we’ve still got to manage the short-term emergency.”
We have been trying desperately to keep people spending, for the sake of jobs, for many years. We have flooded our media with advertising to glorify consumption. We have planned obsolescence. We have repeatedly created bubbles to generate artificial wealth which can be spent. Now we want to move pension savings towards immediate consumption, and to hell with the future, which will be under water anyway. It’s Frankenstenomics, artificially stimulating the corpse of the eceonomy into one more despairing twitch.
It is a civilisation that is going to go the way of the Mayas, the Incas and the Easter Islanders, and which knows it, and which has given up.
I am not persuaded by CDC. There is some logic, if annuities are a big money spinner, for annuity-like payments to come direct out of the pension fund, and this is a hint at how CDC would work. This means that there is a mechanism for intergenerational risk transfer, which in theory should smooth out the bumps we get with temporarily low interest rates.
The trouble is, how do you know the interest rates are only temporarily low, or high. In the mid 80s we would never have believed interest rates of the 00s would be as low as they were. Ditto returns on equities and changes to life expectancy. Try to smooth out what is a trend and not a blip and you can land yourself in a heap of trouble.
In particular if you start to make a transfer from savers to retirees, this is a big signal that all savers should get out of your fund straight away and put their saving into a new fund. If they have any choice in the matter. Oh, these are company pension schemes. OK right then.
This is financial engineering of considerable complexity. You thought the actuarial calculations of annuity rates were bad. But the problem is that we’ve been trying too hard to insure too much risk and drained away too much value. The governments reform recognised that it is unfair to force people into this.
I have a suggestion, which I will write up into a separate article, that cheaply and simply insures against the bigger risks of longevity and running out of money, but doesn’t try to do too much.
Joe Otten : But the problem is that we’ve been trying too hard to insure too much risk and drained away too much value. That’s a neat encapsulation.
What would I look to do as an alternative? Well rather than invest in UK government securities and blue-chip corporate bonds, I think that peer-to-peer lending and microfinance – both here in the UK and to enable small businesses to get up and running in emerging economies – might be interesting. As might VCTs where it is shown that the VCT is being used to help fund ethical, green startups.
The bottom line is that removing the limitations on what can be done with pension money that, sure, as described above might be used to fund immediate consumption (why?) but can also result in imaginative deployment of capital that is currently moribund.
I have long taken the view that if Janice Turner says something it is sensible to listen.
We would do well to think when she reminds us about the danger in the past of the elderly ending up starving in hovels. In Food Bank Britain that is becoming a reality for some.
For the reasons set out by Chris Huhne in The Guardian this week I would caution people against swallowing all the media froth about Osbourne’s Tory Budget.
It is important to remember that it is a Tory Budget, that is how the voters see it according to the opinion polls, if there is any political gain from this it will go to The Tories. There is no political gain for Liberal Democrats in this budget. Danny Alexander can tour the TV studios until he is blue in the face ( and considerably fatter in the face since he became a minister — always a bad sign) but he will not be able to squeeze one percentage point of opinion poll support forLiberal Democrats from this Tory Budget.
Janet’s positive,suggestion in her final paragraph seems like good sense. Why shouldn’t Liberal Democrats unite around her proposal?
Janice Turner
“The big problem that this does nothing to solve is the poor quality of DC scheme design that we inherited from Margaret Thatcher and which Labour did nothing to improve.”
Check your facts, the major problems for pensions happened under Gordon Brown. That is not to say the 80s/90s tories were great for pensions but the real problems come from New Labour.
“the government is blithely unconcerned about people blowing it all on a Lambo – but eventually it could become a big problem for government as it could undermine the whole purpose of autoenrolment.”
Seriously? Is that your level. So a low paid person may get a pension pot of under £50k not enough for a “Lambo” any way. We are talking about people in their 60’s here, not a 13 year old. If someone has saved enough to buy an expensive car they are probably good at managing their money and not inclined to do it.
If you think someone who would be saving through autoenrolment can afford a supercar you have a seriously skewed view of the world.
“Others, perhaps those on lower incomes who are short of cash anyway and have quite a small pension pot, may just spend the money on paying off the mortgage, paying bills or buying a new car.”
Errr? well if you are suggesting that someone with a small pension pot shouldn’t pay off their pension but buy an annuity, you have serious issues with money. The interest rate over time on their mortgage will be higher than the return on the annuity. The financially sound thing to do is to reduce the unavoidable outgoings as far as possible before purchasing an annuity. Again you seem obsessed by cars.
Frank Booth
“It’s all very well giving people freedom but they have had all manner of tax breaks because they were saving for a pension.”
I think you misunderstand the nature of pensions, it is tax deferral not tax breaks. You don’t pay tax on it when you put it in because you pay tax when you take it out. So lets take your example of someone who earns well say £55k pa for the higher earning bit of their life and they are very luck and manage to build up a pension pot of £300k if they take it all out at once they will pay 45% on half of it when they deferred paying 40% through their working careers so by taking it out as a block (which you would be mad to do) would mean you pay a higher tax rate in the end.
David Allen
“Well, not if the State has subsidised your pension pot using other people’s money, on the understanding that you would use it to draw a pension”
See above
“the Lamborgini”
See above, I think some people have a rather odd obsession on here.
Paul in Twickenham
Excellent comment, perhaps you can start the “de-Lambo” treatment for some people on here who have an odd world view.
I am intrigued by what the combination of the pensions reforms and the means-testing arrangements in the Care Bill would be and whether they would expose local government to increased liability for social care funding in old age over the projections already done as justificaiton for the Care Bill in its current form. Has there been any reseach done on this or any meaningful discussions between the treasury, the DCLG, the DoH and the DWP? (I suspect not)…
I suspect there are quite a few people in my position. 40% tax payer when working 20% when retired. So it is not totally deferral but some other nice tax payer topping up my fund.
What happens if you take the lot and have a sudden emergency requiring lifetime residential care? The pot will be rapidly run down as you will be self funding leaving very little for any partner.
Peter Hayes
Yes, tht is the point, you pay it when you draw it and tax at the legal rate. That is not the tax payer topping your fund up (unless you have been engaged in some form of fraud).
Your point about residential care is something that people will have to decide for themselves making that assesment. A change in the system doe snot require that all risk is removed from every person inthe country, as the current system doesn’t offer that.
There’s also the question of how Janice’s big state solution is liberal, it seems to be identical to Old Labour. I can cope with Owen Jones coming out with stuff like this, but not Lib Dems. There are plenty of SMEs in the City, but apparently we should forget about these, pretend they are all big and bad and replace the whole pensions. annuity, advice and insurance industry with Quangos.
@JohnTilley
“It is important to remember that it is a Tory Budget, that is how the voters see it according to the opinion polls, if there is any political gain from this it will go to The Tories. There is no political gain for Liberal Democrats in this budget.”
Well it’s a Tory/Lib Dem Coalition Government Budget actually.
And the Pensions element of the Budget that we are talking about here is probably far more down to Lib Dem Minister Steve Webb than to any other member of the present Government. If that is indeed the case, then we need to be telling people that.
So sorry for being so, so boring, but doesn’t Janice’s contention that “a pensions move could negate the whole point of pension saving” say it all. Surely, people contribute sums during their working lives, be it to the state or others, in order to ensure an income in their retirement years. Shoot me for being too simplistic, and I am aware of the vagaries of the financial markets, but it should be within the wit of a body of the intelligentsia to devise a universal pensions’ scheme that is less volatile than that that is dependent upon the performance, or under performance, of the financial markets. I am not a wholesale supporter of “the collective” but there are areas in which the “collective” is the fairest and the most equitable solution.
“it should be within the wit of a body of the intelligentsia to devise a universal pensions’ scheme that is less volatile”
Unfortunately that attitude is a major problem with how we end up in messes.
In the past people believed that if they worshiped a god(s), carrying out rituals/making sacrifices then that would deal with the volatility of the weather. It didn’t work, though some of them may have believed it when there was a run of good weather (and explained away the reversion to the mean as “punishment” for misdeeds).
These days we come up with some kind of alternative such as a pay as you go (or Ponzi depending on your view) scheme. However these schemes, when compulsory like state pension, allow one generation to over promise themselves benefits that are, in effect, being borrowed from the next generation. A situation exacerbated by politicians short term time perspective wanting to buying off voters. These schemes base assumptions on previous population trends (as opposed to financial market trends) so they assume populations will grow at historic rate (and productivity increases at historic trend rates) and come unstuck when the population ages as birth rates drop. This not only damages the affordability of the scheme but also damages future economic growth due to a vast debt burden.
Voluntary schemes come unstuck when the market return drops and the funds will not be able to attract new savers to the scheme so those who retire early are save and leave those who retire later to have little chance of getting a reasonable return.
Funded compulsory schemes simply end up with a shortfall issue that suffers the same incentive pressures as the pay as you go scheme (making under funding more likely) with a slightly lower burden.
None of these are great. The current proposals are not perfect but at least it allows you if you had planned to retire at a time when interest rates are low and therefore annuities have terrible returns to:
– Flex the age at which you retire to try and avoid that problem
– Potentially draw on capital until the annuities become better
There is risk in any scheme but voluntary approaches are better than compulsory ones.
There is to intellectual titan who can remove risk from our economy and if someone claims to be we should regard them as dangerously deluded. Remember Gordon Browns claimed to have ended “Boom and Bust” and the disastrous demise of British Pensions on his watch.
The best we can do is provide flexibility, make guidance available (and affordable), prevent governments raiding pensions and provide a level of basic state pension that allows people to survive live.
Interest rates are low, asset prices seem to be increasing at the real rate of inflation.
The whole point is not to put all your wealth into one asset. i.e. one annuity, one property, one vehicle or one company share, but to invest diversely. If the product is too expense to buy one unit than find an alternative investment.
I was thinking along the lines that I rather buy into several stocks & share ISA type funds, many offering a better yield to investors than a low yielding annuity.
I didn’t mean to get moody over this. I sometimes go moody at the start or half-way through debates, but never like to end on a bad note!
Best wishes