The UK pension system lags many of its European peers in a report out this week, which recommends restoring the requirement to take savings as an income stream.
The freedom and choice policy, brought in by then-chancellor George Osborne in 2015, has radically altered the UK pensions landscape. But the freedoms, which did away with the requirement to buy an annuity for most people, are now seeing a backlash from MPs and industry.
The Work and Pensions Committee launched an inquiry into the effects of the policy last month. Evidence submitted stated that a vulnerable adult took out a pot of nearly a quarter of a million, losing much of the money to tax and spending the rest on alcohol, gambling and a car.
The objective of a pension system is to provide a retirement income. That doesn't necessarily mean an annuity
David Knox, Mercer
The Financial Conduct Authority’s Retirement Outcomes Review interim report showed that a quarter of people who have accessed their pots since April 2015 have spent all or most of it, although of those, only 3 per cent had no other sources of retirement income. Before the freedoms, 90 per cent of pots were annuitised.
The Melbourne Mercer Global Pension Index 2017, compiled by the Australian Centre for Financial Studies and consultancy Mercer, ranked the UK just above average based on the adequacy, sustainability and integrity of its pension system. While the UK did well on integrity, it scored just below average on both adequacy and sustainability.
As the first measure to bump up the British system's score, the report recommends restoring the requirement to take part of retirement savings as an income stream.
Defaults could provide path to income streams
David Knox, a senior partner at Mercer and one of the report's authors, said the goal of a pension system must be to provide an income. "It goes back to the objective of a pension system – it’s to provide a retirement income. That doesn’t necessarily mean an annuity."
Knox said there needed to be a product that provides flexibility but predominantly has an income focus, such as a flexible drawdown product that contains an annuity element.
His main concern with giving retirees the option to take their money as a lump sum was not that people deplete their pots before they die, however. “One of the dangers is if you don’t have that provision then people start to self-insure, they hold back because they’re fearful they might live to 100,” he said. “Then they die, leaving money on the table. If that’s the case then our view is that the system is not achieving its long-term objective.”
He suggested introducing a default approach with a provision to opt out, which could be a combination of a flexible drawdown product and annuity protection. The flexible drawdown could have a provision to access capital components, he explained.
This might also avoid giving the impression of taking away the freedoms, something politicians might be reluctant to be seen doing.
Should cashing in come with strings attached?
But Steven Cameron, pensions director at provider Aegon, doubted the report’s recommendation was viable.
“A government that has other things on its mind is unlikely to take on this particularly controversial change,” he said.
For Cameron, the ideal solution would be a softened form of what was in place before freedom and choice. Prior to the freedoms, people were allowed to cash in their pension provided they had a secure income of at least £20,000.
“Osborne took it to the extreme, you could cash in your pension pot full stop, no restriction on having a secure income,” he said.
Instead, “we could have had a slightly less radical approach, to allow people to do what they wanted provided they had a much lower income of maybe £10,000 a year” including state pension, he proposed.
“The problem is, to try to introduce that now would be much more difficult. It would be seen as the government kicking away a freedom.”
Freedoms work well for the ‘haves’
Having a cash option “requires that the population is sufficiently informed to make good choices”, said Mark Sullivan, senior vice-president at Fidelity Benefits Consulting. He said he doubted this was the case.
The freedoms, he argued, have mainly worked for the wealthy: “Pension freedoms enable those who have amassed more to better manage their outcomes.”
This was because they are better able to take advice, more financially experienced to make better decisions for their long-term future, and better able to withstand market volatility, he said.
Select committee probes pension freedoms as concerns grow
The Work and Pensions Committee is launching a new inquiry into the pension freedom reforms, asking whether changes are required to better achieve the policy’s objectives.
Sullivan is convinced an income requirement will have to be reintroduced as the population is ageing, saying state pensions will become less affordable.
“The government will have to mandate, encourage or otherwise for people to have to take their retirement as income rather than lump sums.”
