A new year, another new pensions idea

So it appears Steve Webb spent Christmas thinking about pensions. (Well, didn’t we all? No?) And not satisfied with the pension freedoms promised for new pensioners this year, he’s been thinking about those who have already bought an annuity. After being told cashing in annuities was a no go, his new idea is to allow people to sell their annuity. In exchange for a lump sum, the buyer will continue to receive an income as long as the original annuitant lives.

I can see the appeal of this idea. But is it really in the consumer’s interest?

Let’s take - the highly simplified – case of fictional Freddy. At the age of 60 he bought an annuity with his £100,000 pension fund. Freddy had high blood pressure and high cholesterol, but he didn’t shop around, and instead bought an annuity from his original pension provider. So he got an income of £4,000 a year after tax.

Now, at age 65, he wants to exchange his annuity for a lump sum. The prospective buyer gets him in for a full medical, finds out he isn’t very well, puts a life expectancy on him of 12 years (which comes as bit of a shock to Freddy). So Freddy is giving up a total annuity income of £48,000. If we discount that in today’s money terms to take account of inflation it is perhaps worth £41,000. And let’s say the prospective buyer takes off a bit (partly because they are putting up the capital up front, and, partly, because they can), so they offer Freddy £37,000 for his annuity income. (I did say this was a simplified example.)

A full medical is going to be a necessity. Those who come up with shorter life expectancies won’t be offered very much for their annuity stream. And those with a longer life expectancy would probably be well advised to keep the annuity and get as much out of it as possible.

And who buys the annuity? I can see annuity providers might see this as a neat business prospect (especially in the New Freedom World when fewer people are going to be buying annuities), but presumably they have to buy second hand annuities in bulk to make the business proposition work. So only a few companies will be able to compete and that is never good news for the consumer price-wise.

And is tax still paid on the income stream according to the recipient’s tax status? If so, that may mean swapping to only 20% corporate tax. And in that case the Government may want to stem its potential losses and apply a tax charge upfront on sale of the second hand annuity. If so, that’s another big tax take for the Government today, rather than waiting for its jam tomorrow from annuity income.

(As an aside, if the tax is determined on the recipient’s status there may be a future market for higher rate taxpaying annuitants to sell their annuity to their lower taxpaying spouses or partners.)

Webb is fond of saying he favours setting people free, to spend their money as they see fit. But whilst this is difficult to oppose, I refuse to accept it as the blanket clincher to every argument. If the policy runs the risk of putting a significant number of people at a disadvantage then we need to stand up and say so.

This all boils down to the appeal of hard ready cash. Fictional Freddy will probably jump at the chance of £37,000 cash in hand. Most people prefer to have the cash in their bank account to do with as they will, rather than the steady drip of an annuity. And that creates eager sellers, and the probability of a dysfunctional market.

Annuities are not a bad product. But the way they have been bought has led, in some cases, to poor outcomes. But none of the pension freedom initiatives have addressed the basic problem that people have failed – and will continue to fail – to shop around.

I wish instead of considering traded annuities, Steve Webb had concentrated his energies over Christmas into thinking about how he – together with the FCA – can improve the way people buy retirement income products. So instead of policy kite flying, we could have had some productive practical policies to help people now and from April.

Chicken Licken and the pension credit card

This week’s storm in a teacup award goes to the furore surrounding ‘pension credit cards’.

Ever since we heard about the reduced tax on death in retirement we have had the phrase pensions bank account bandied around in the media. It certainly grabbed the public’s imagination – and was a definite improvement on talking about ‘UFPLS’ which was the concept it was employed to describe. At least people understood what it meant. But as soon as we had pensions bank accounts then that led to speculation about pension debit and credit cards and being able to get your pension income from a hole in the wall.

But it has left the pensions industry – and in particular pension providers – running about like Chicken Licken predicting the sky is about to fall in. They are frantically worried about people accessing their money easily and simply, saying that it is sending out the wrong messages, pensions aren’t the same as bank accounts, it will only encourage irresponsible behaviour, people will just go on fancy car spending sprees, and end up with nothing for their later life. Plus it just can’t be done with the amount of paperwork involved every time someone takes an income withdrawal. Plus we – the ‘traditional providers’, that is - are not going to be in a position to do it for a while yet.

I find this an over the top reaction. Let’s get a few things straight. The minute the Treasury created pension freedoms they created the big risk many people will outlive their money. Whether they go on fancy spending sprees, invest it in a too risky environment, invest it too cautiously, underestimate their lifespan – whatever. There are a hundred and one reasons. Giving those people who want it, easier access to their money is not going to really affect this in the big scheme of things. Many people risk running out of funds regardless. I’m afraid that is now life.

And the paperwork point. All this can be overcome with a good will. Just because we have always done income drawdown withdrawals this way doesn’t mean we can’t reform and improve. Those who want to get around the paperwork hurdle will do so.

Providers seem to naturally be taking it on themselves to be the guardians of ‘proper’ consumer behaviour. They are advocating they give the consumer numerous warnings about the risks of running out of funds, and warn of the terrors ahead. They should be applauded, of course, for this. I can’t – and won’t - object to people receiving the right warnings at the right time. But I am at a bit of loss why providers want to don this particular hair shirt, and take the responsibility solely onto their shoulders.

Government created pension freedoms. Government created the vision responsible people will use their funds as they see fit. Government also created the regulator – whose job is to ‘protect consumers, ensure our industry remains stable, and promote healthy competition between financial services providers’.

So, instead of pension providers sat there on the beach like King Canute telling the waves not to come near, they should accept that pension bank accounts and credit cards will happen.  Somebody somewhere will innovate to introduce it. And very soon after April 2015. People will like it and use it. The momentum was created when the Treasury first uttered the words ‘pension freedom’, and it is, to some extent, unstoppable. The genie is already out of the bottle. The idea is already out there.

 I don’t think providers should have to solely take on the role of moral guardians – although they seem very keen to do so. The only one who can halt this particular development is the FCA. If taking pension income from a cashpoint will really encourage very risky behaviour and is a Bad Thing, then it’s up to the FCA to stop this. I appreciate the FCA has a list as long as your arm of what it has to do before April, but this is its job. It’s there to protect consumers and maintain a stable industry.

So, please can it engage in this discussion and say where it stands. Because pension credit or debit cards are coming to a cashpoint near you. And soon.

Automatic enrolement's mid-year report

In 2014, the pension pundits prophesised, automatic enrolment will hit the rocks.

So far the implementation of `automatic enrolment has been relatively stress free. Employers have been doing what they’ve been told to do and enrolling their workers. And employees have also towed the line and stayed put in their pension schemes and paid their money. However, as the size of the employer staging began to get smaller, we all got a little bit jittery. Would employers comply? Would employees opt out? Would there be enough provider capacity?

As the end of 2014 draws into sight we are getting a better idea of how this year has gone. Or at least the first half of it. Evidence of employers’ non-compliance is starting to appear and the Pensions Regulator has issued its first fines – a £400 fixed penalty each for three employers who were April stagers but failed to meet their automatic enrolment duties. As the number of employers staging has gone through the roof this year, I think only three fines is impressive. It seems employers are getting to grips with automatic enrolment, although I am sure there will be more hiccups along the way.

And it also seems employees are also comfortable with the concept. The Department for Work and Pensions (DWP) has just released its qualitative research into employer compliance and opt-out rates. 46 companies were involved in the research. Their staging dates fell between January 2014 and July 2014 and the research covered 7,200 employees (the employers researched had between 90 and 499 employees each). But 44% of the workforces were already members of a pension scheme, and only 35% were automatically enrolled (the other 21% weren’t eligible for various reasons).

Out of those automatically enrolled 12% opted out. OK, that’s a rise from the 9% reported for the 2012/13 intake, but still in the great scheme of things a good solid result. Even when you take into account that a further 2% stopped contributions in the two or three months after the opt-out period closed, bringing the ‘real opt out rate’ to 14%.

Those who opted out tended to be older and/or part-time workers. The main reasons they gave were affordability, already having adequate retirement provision, being close to retirement, employer contributions being too low, or planning on moving jobs soon. So far, all very predictable.

But the research is also interesting for what it tells us about how employers are tackling the automatic enrolment problem, especially when compared to bigger employers last year. For example their implementation costs were a lot lower – usually between £200 and £700. That’s mainly because they did the work in house – the HR professional just added it to the long list of other work they had to do. Bigger employers last year employed consultants and got legal advice so pushing their bill skywards. Instead, the main cost for the employer class of 2014 was time. And their advice to other employers is to take six to nine months to prepare, rather than the three to six months they crammed the changes into. You have to feel sorry for the poor HR professional who got automatic enrolment dumped on their desk.

Of course, smaller employers enrolling later this year and over the next couple of years won’t even have the luxury of a HR professional. So, either the boss will have to do the automatic enrolment work or they will have to employ someone else to do it, which would add to their costs.

This year’s employers are comfortable they can cope with future administration costs. But the escalating cost of employer contributions worries them. The way they think they will cope is by adjusting salary, slowing recruitment or increasing prices. All obvious strategies. I would like to see - in time - a bigger study by the DWP into how employers coped with the costs, and the implications for the labour market.

Finally, the other major concern at the start of 2014 was if there was enough provider capacity to cope with all the employers staging. For our sample of employers that didn’t seem to be a problem. The majority used mastertrusts and the most popular by far was Nest.

So, what’s the verdict of the mid-year report into automatic enrolment? Well, all things considering, it seems to be going fine. Not too many employer fines and a nice low opt out rate. And Nest hasn’t fallen over. Yet. One cynical thought, however, is 46 employers is a very small sample out of the thousands who had staging dates between January and July, and so there are always going to be problems which the research hasn’t uncovered.

Another concern is these are still employers who are pensions savvy – almost half the workforce are already pension savers. Once we move onto employers who are pension virgins, however, a different picture might emerge.

Is the shine coming off pensions freedom?

It’s very hard to argue against the words ‘freedom’ and ‘choice’. So when the Budget announcements hit us in March, they were met with mainly enthusiasm. Most commentators and pension experts agreed giving people more choice was a positive thing. There were concerns, obviously, but the overall atmosphere was one of optimism.

But as time has gone on, we have learnt more about the proposals, and the legislation is now taking shape. And it now seems as if doubts are creeping in about the new world and the potential for people to lose out.  These doubts appear to be clustering around the following:

·         Guidance guarantee – we now know who will be delivering the guidance guarantee, but we don’t know what it will look like, what it will cover, or how and to whom it will be promoted. To get people to take it up we need to sing about it from the rooftops but we are running out of time to get this right.

·         FCA regulation – the FCA has said it will not be strengthening its rules ahead of April, instead relying on the guidance and seeing how that develops before introducing anything new. But there are growing calls for it to develop a ‘second line of defence’ to protect those people who don’t get advice or guidance.

·         Annuity bashing – there is a growing concern the Government and others are ‘annuity bashing’ by positioning annuities as a toxic product, even to the extent of suggesting some annuities should be unwound. A more informed discussion about annuities needs to happen (by all) and how they could help secure a valuable stream of income for retirees.

·         Defined benefit transfers – those with defined benefit pensions may decide to transfer to gain advantage of the hyped pension freedom. Of course, after April, they will need to have taken regulated advice, but even if the advice is to stay put that may not stop some determined individuals, or those who decide to jump ship before April.

·         The risk of running out of funds – the latest survey (from Hargreaves Lansdown) suggests 12% of savers are expected to blow their pension pots next April. But equal to the risk of people just squandering the whole lot, is the risk some will withdraw their funds (either gradually or in full) from pensions, pay too much tax, end up in poorer or higher charging investments, and outlive their funds. The Government, however, appears to be laissez-faire about the risk people end up with just a state pension in their later retirement. The other side of the coin, obviously, is the tax windfall the Government can expect from withdrawn funds.

I’m not saying the reforms are ‘doomed’. Of course, they’re not. But these concerns need to be addressed and resolved before the system goes ‘live’. Unfortunately, however, the Government appears to be resilient to admitting anything is amiss.

The pensions freedom agenda is a fantastic opportunity. But the Government needs to listen to the growing concerns and do something about them. April 2015 is only 160 days away, and there is a lot to do. The Government needs to have courage and if it – and the FCA – can’t achieve what they need to in the time we have left, then the reforms need to be delayed until October 2015 or April 2016 rather than risk people making the wrong decisions.

But these reforms have been brought about on the back of a political agenda. And with a May 2015 election looming, there is no chance the Government will delay them and risk looking bad. There is simply too much riding on this politically.

That’s a shame. I don’t think we don’t have enough time to prepare the ground and introduce these reforms in the right way. And instead the Government is putting politics ahead of people.

 

Better regulation please

Another week, another pensions reform announcement. At the moment, the pace of change feels relentless.

But, for once, the detail of this particular announcement wasn’t important (even to pension geeks like me). Instead, what was significant was the packaging of the announcement, and the reactions it provoked.

Let’s cover the detail to start with. Under the new rules, (if schemes offer it) people can take money from their uncrystallised funds once they reach the minimum age. 25% will be tax free, and the rest taxed as income. This differs from drawdown, where the whole 25% tax-free cash can be accessed in one go, without touching the other funds.

This is not news. We knew all this from previous HMRC announcements. It had even been given a (typically) non-friendly pension acronym of UFPLS, just so normal people wouldn’t have a clue what it meant. And it had two functions. First, to allow a form of phased retirement. And second, to help those schemes who didn’t want to go to the trouble of introducing drawdown (FAD) to provide a way of allowing their scheme members access to their funds on retirement.

But all this has been turned on its head. The Treasury has taken this concept and packaged it very neatly indeed. The headlines this week scream out ‘access pensions bank account’. Isn’t that lovely and friendly? So much better than UFPLS, don’t you think? I think it’s a masterstroke. UFPLS goes from an unloved unwanted concept to a must have.

But it has provoked strong reactions. One must be fear amongst pension providers and schemes. They were busy drawing up plans to offer drawdown to scheme members from April. Only those who couldn’t be bothered with that would have even considered UFPLS. But now, all schemes will be forced to at least think about whether to offer it. Otherwise they risk denying members their ‘freedom’.  (Although my experience is most people want to simply take all their tax-free cash in one go as soon as they can.)

Getting this additional requirement in place for April is going to be a headache schemes and providers can do without. Plus can any provider or scheme live up to the promise that the phrase ‘pension bank account’ evokes? Will people be able to get hold of their retirement fund from a cash machine? Doubt it. The banks with their technology, however, may become interested in accepting transfers of pension funds.

Another reaction is the ‘freedom vs protection’ debate. This has been simmering for some time, but has really caught fire this week. On the one hand some argue people are responsible savers and will therefore be responsible spenders. We should give them the freedom to take their money when and how they want to. And these latest announcements – pensions bank accounts and changing tax rules on death – only encourage people to do the right thing, and not squander their money but leave it in the pension environment for when it’s needed.

On the other hand, there is a growing voice arguing that we are creating a whole host of freedoms with little or no regulation, and that this has the potential to end nastily for some.

I find myself in the latter camp. Of course I trust people. Of course I think they are responsible. But I know that taking a sum of money and making it last for a lifetime is a really difficult trick to pull off. People need to be aware of the risks and if possible protected from them. And that’s the job of good regulation.

The Treasury is hell bent on creating the tax environment for pension freedom. Let’s be honest, it’s a vote winner, at a time when winning the ‘grey vote’ (before it walks to UKIP) has never been as important. But the FCA seems to be on the back foot and playing catch up. It has been thrown several balls over the past few months and is struggling to keep them all from dropping. The flagship of the guidance guarantee is obviously its focus. But its regulation around retirement income is woefully inadequate for the new world.

I’m sure the FCA is busy working on rectifying this. But decisions are being taken now by advisers and people about retirement income, even though the new rules don’t come in until for another six months. So, we need to see updated regulation, including how to protect people under the new rules. And we need to see it soon.

Can we force people to seek out guidance?

The party conference season is, thankfully, drawing to a close. With such a packed pension policy agenda there was never going to be a lack of subjects to chew over. One area always bound to come under scrutiny was the guidance guarantee. And at one fringe event, some were making the case for guidance to be compulsory – rather than relying on people seeking it out themselves.

I can see their point. The retirement market was broken. Before March, too many people ended up buying poor value annuities, probably on the wrong terms for their personal circumstances. But whilst the FCA took its time investigating why in a seemingly endless series of reviews, the Treasury steam-rolled in with a – dare I say it? – lucrative (for them) solution of just getting rid of annuities. Cos that’ll solve the problem right?

I’m not sure it did. And it certainly created a whole host of other problems.

People will now have the freedom to use their pension money in the way they see fit. The problem is, will they know what the best solution is for them? Or will they squander the money? Or hoard it in a poor investment? Or be fleeced in an inevitable scam?

The solution to this, of course, is retirement guidance and advice. Without these, I really don’t think pension freedom can ‘work’. But we need people to seek out and get the guidance they have been promised. And from there hopefully be encouraged in buying advice from a professional adviser.

But the signs, so far, from endless focus groups, aren’t great. Predictions of take-up of guidance range from 10% to 50%. We need to aim higher. But how do we do that? And that’s what led those in favour of compulsory retirement guidance to make their case.

But how do you compel someone to get guidance? One solution may be to bring in a requirement that unless the person has accessed advice then they can’t have a retirement product. But this won’t work on many levels. What happens if they aren’t buying a retirement product? And instead withdrawing the lot and squandering it on a new kitchen (although that doesn’t sound like ‘squandering’ to me)? Or putting it into an ISA? Or if a scam is involved I’m sure there will be devious slights-of-hand to bypass this new requirement.

Maybe instead we should have more draconian requirement that people cannot access their money until they have taken guidance. But are we seriously going to tell people they cannot get at their money? There will be outraged, and quite rightly so. In the end, compelling people to take guidance could simply mean they will be so put off acting they will leave the money where it is and survive on their basic state pension, when, in fact, they are entitled to a much higher retirement income.

Compulsion won’t work. We have to signpost and encourage people to get guidance. It won’t be easy. It will cost money. And results will start off poor. Guidance needs to be mentioned every time we say retirement. We need to ram it down our poor customers’ throats. We need to drag it up at each and every opportunity. We need it in big shiny lights on everything we ever do which mentions future income. And by ‘we’ I mean providers, advisers, trustees, consultants, employers, government agencies, regulators, media, social media, government departments, debt agencies, CAB and so on and so on.

This has to be a collective effort. Otherwise it won’t work.

And once we have successfully got people into guidance, we need the best method of getting them out the other side. Hand offs to professional advice need to be everywhere. The FCA needs to seriously think about the next steps people can take, and what role a new type of simplified advice could play. We cannot push people though guidance and then leave them washed up, gasping for air, and nowhere to go.

Guidance seems a simple easy concept. But it’s not. This is tricky. Very tricky. But we need it to work so the new pensions freedom can also work. Otherwise 2015 and onwards is going to be one big mess.

A mighty big shove into drawdown

The industry was still reeling from the Budget announcements for pensions reform, when yesterday the Chancellor once more waded in with changes. From next April payments from drawdown funds on death of the member will be tax-free if the person dies before age 75, and subject to either marginal rate of tax or 45% if the member was 75 or older.

This move, of course, appeals to many people's basic instinct to try to leave as much money as they can to their family. Even though the Treasury hurriedly reassured the industry that value protection paid out on death of an annuitant will also be tax free (if they die before 75), this still means drawdown compares very favourably against annuities when considering death benefits.

The obvious consequence is that although it has been predicted that many more people will go into drawdown after April, that number has swelled. This move, by the Coalition Government, is designed not to ‘nudge’ people into drawdown, but to ‘shove’ them right in.

And, I don’t believe that is a good thing.

There are well-documented risks with drawdown. The fund is subject to both investment risk, and the risk of people living longer than expected and therefore running out of money. (Although personally I think living longer than expected sounds quite good.) Drawdown is also expensive. Note there is no 0.75% charge cap on crystallised funds, unlike the one which will exist on accumulation funds. And guarantees on drawdown sound great, but could cost the earth. Put simply drawdown is not the right solution for everyone, or at least with all of their fund. It depends greatly on their personal and financial circumstances, the ongoing advice and help they receive, and their attitude to risk.

Now, don’t get me wrong. I love the idea of greater pension freedom. I love the idea of less chance of paying tax when you die. But I also think annuities are a good product for a lot of people, and I want people to take them out, with at least part of their fund, or at some point in retirement. I want them to have security. I want them to have an income that is guaranteed no matter what. Annuities can be - and should be – improved, but there is absolutely no reason to bin them altogether. They play a vital role, especially when combined with drawdown. But the pendulum is in danger of swinging too far the other way in drawdown's favour and eliminating people's want for annuities.

So instead I would like to see a more even playing field. Change the rules so dependants’ annuities are also tax free (if the member dies before age 75). And make sure value protection lump sums are also subject to marginal tax (rather than 45%) if the member dies after age 75.

Because this boils down to one question. Are we completely happy that all the people use all their retirement fund all the time to invest in drawdown? And if we’re not – and I for one am not – then we need to create a level playing field so both drawdown and annuity can work together to provide people with a secure, but aspirational, retirement income.