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.

Confused? You will be

I have just spent an entertaining morning trying to figure out HMRC’s new draft retirement income rules. What a palaver!

There are brand new options and brand new acronyms to get our heads around – UFPLS and MPAA to name but a couple. And new rules about what you can take and when and what proportion is tax-free. It’s a technical geek’s paradise. You will never need to speak English again – just initials.

It’s great to have choice, but this is no picnic. The rules aren’t simple and straightforward, and professional advisers will need to understand the pros and cons, and importantly the tax efficiency, of each route – and what schemes are prepared to offer – before advising their clients.

One of the biggest problems of the old (current) regime was people didn’t shop around for an annuity, and too many settled for an inferior rate with their current provider. But all of these wonderful new rules don’t tackle that essential problem.

HMRC is removing the compulsory requirement to offer members an open market option. Apparently, this is only a legislative tidy-up exercise, and I sincerely hope that when Government re-introduces the requirement, it extends it beyond just those buying an annuity to also apply to those plumping for a FAD or UFPLS as well. My worry is that if the majority just settle for their new options from their current provider then they may not be making the best decisions for their circumstances. They could lose out on eye-watering charges, abysmal investment performance or choice, or poor administration. Hopefully, guidance will nudge people into shopping around, but I would like the legal OMO requirement back all the same.

Anyway, good luck in getting your heads around the new rules. In the meantime, I’m going for a lie down in a darkened room to recover ...

Who will advise the new advice seekers?

I firmly believe this new regime of choice and freedom in pensions will only ‘work’ for customers if we have two things. The first is better tax rules allowing innovation in retirement products such as annuities. (And that’s been promised by the Treasury – draft legislation is due out soon.) And the second is impartial guidance to help people understand their options on retirement.

This is the challenge that now faces TPAS and MAS and others. Design an effective guidance guarantee so that people understand their options and what they can do to provide themselves with an income for the rest of their life.

The accepted wisdom doing the rounds at the moment is that the guidance will explain people’s options to them. And it will hopefully spur a number (as yet unspecified) to seek professional advice to figure out which of these options is best.

I have no doubt that this supposition is right. Some people will seek advice. But what I am curious about is who will advise these new advice seekers?

The FCA has mooted the idea that as advisers will benefit from this new source of customers they should pay some of the guidance costs. But one adviser’s reaction on seeing the potential FCA advisers’ bill for 30% was (and I paraphrase) “why do I have to pay? I don’t want these clients anyway!”. And I think that probably rings true for a number of professional advisers. Sure, there will be some ‘value’ cases that professional advisers will be happy to add to their books. But some of these potential customers will have assets that fall below some advisers’ target markets. And although these new customers may be willing to pay – and see the value in paying - for advice they may not be able to afford quite that much.

So, what will happen to them?

This is a genuine question – I would like to know your thoughts.

Am I wrong? Will all these new advice seekers get swallowed up by the professional adviser market? Is there enough capacity and appetite out there?

Will professional advisers develop some sort of new proposition to be able to ‘service’ them in more cost-effective ways? And can they do that under the current FCA rules?

Is there a role for simplified advice as it stands? Or does it not make economical sense? (If you are employing a professional adviser, then is it just more sensible to let them offer a full advise service? After all, that’s what they are trained to do.)

Or do we need a new solution? I would hate it if we created a new breed of customer who actively sought professional advice but was unable to access it. Even if it was just a handful of people.

Answers on a postcard please ....

What to look out for next week

It’s fast approaching the time when Parliament breaks up for the summer. But before it does, the Treasury has an important job to do. If it wants to get the new pensions freedoms and guidance (proposed in the Budget) in place by April next year then it needs to get its skates on and get the legislation sorted. Time is of the essence.

The first step is Treasury issuing a response to the Budget consultation (which closed in June) before Parliament packs up and go on holiday. In other words, by next week.

This is important stuff. The new proposals are far-reaching, explosive, liberating, and exciting. But they are potentially dangerous for people. It’s great that we are introducing them, but it’s imperative we get the context right. Or else, things could get messy.

Right legislation will lead to new product development creating the right solutions for people. And the right guidance means people can make the most of what’s on offer. My worry is that under the new regime instead of people failing to shop around for an annuity, they fail to shop around for drawdown (or whatever product). If we end up with 50% of people simply rolling over into their current provider’s drawdown fund, then we have failed.

So what am I looking out next week from the Government’s response? Three things.

1.       Flexible legislation. Ideally, the whole legislation underpinning ‘retirement products’ could do with a good sort out and a re-write. But the Treasury hasn’t got the luxury of time. But I do want to see legislation that is flexible enough to allow innovative and useful product development. For example, let annuities go down in value, if that means we can design products that fit the way people want to take income.

2.       Impartial and effective guidance. Getting the guidance right is tricky. Getting the guidance right in the ten months they gave themselves is near enough impossible. So although the right foundations have to be laid now, the guidance has to keep evolving and changing until it’s right. It needs to be impartial, and that means asking someone like TPAS or MAS to take it forward. It needs to be there when people want it – not just a one-off. And it needs to involve the adviser community – at the very least handing over to them whenever appropriate.

3.       Sensible response to tax leakage. Once the pension freedom genie was out of the bottle, the big question on everyone’s lips was how will the Treasury stop the double dipping? The ability to invest big amounts of money (because £40,000 is still a big amount of money) tax-free, and then let people take 25% of that tax-free. The answer could be convoluted and difficult. But I am really hoping that the Treasury decides to be sensible about this. A separate annual allowance for once benefits have been taken (of say £10,000)is simple to explain, simple to administer and simple to understand. It is better to have ‘sanctioned tax leakage’ of a small amount rather than build a complicated convoluted workaround that no-one can understand, no-one can illustrate and is difficult to administer.

So that’s it. The Budget proposals were radical, and hopefully, the Treasury will get the next steps right. And it gives us the summer break to absorb all the glorious detail of the proposals whilst the Treasury is hard at work drafting legislation.

The challenges ahead

Today is the day. This is the final chance for anyone who wants to submit a response to the Treasury on the new plans for pension freedom to do so.

I’ve sent my response off and here are my key points. If you would like to read my full response or to talk over any element, then give me a shout at Rachel.vahey@sky.com

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The Budget proposals are to be welcomed, in that they will give people freedom to manage their money as they see fit. And I sincerely hope this will translate into a greater attraction for pensions, and, as a result, more people invest more money to secure a more appropriate income in retirement. That, after all, is why a lot of us are here.

But we are in danger of creating a whole host of new risks, which mean that people may not get full value from their pensions savings in retirement. I strongly believe we need to do everything we can to give them a helping hand to achieve their dreams. Otherwise, by introducing this flexibility, we are not improving their lives, but instead we are merely placing them in a more difficult situation, where they are unable to live the life they want.

For this pension reform to work, we need two things.

1.       We need to deliver an effective guidance service so people are aware of the risks they face, aware of their options and aware how to get advice.

2.       We also need to create the right legislative and regulatory environment so providers can innovate to develop the best retirement income products.

The introduction of the guidance needs to be viewed as a long-term project. Put something in place by April with the right direction of travel, but continue to develop and change the service until it meets the criteria and it is right for the vast majority of customers.

The Pensions Advisory Service (TPAS) is the best placed to take forward delivering the guidance guarantee, working alongside Money Advice Service (MAS) and Citizen’s Advice Bureau (CAB). Providers should not be involved – they are not impartial.

Alongside this, the new service, the regulator and the Treasury must champion - in strong terms – two key messages:

1.       The more people who receive advice, the more people who will avoid the risks associated with the new pensions regime. We must actively encourage people to take advice.

2.       People need to shop around for the best products (whether that’s design or charges or rates). This message is still appropriate and still needs to be pushed.

The guidance guarantee is challenging but it’s crucial. We need to get it right – otherwise the implications will be catastrophic.

Something else we need to get right is the developments of new products. The new pensions regime offers an opportunity for providers to develop the right products which meet people’s needs, and, importantly, their wants and desires. Primary legislation needs to be changed so it is flexible enough to allow this development. Otherwise, people will run the risk of outliving their money in retirement, with consequences both for the individuals involved and for society as a whole.

Finally, I don’t think we should just spend next year designing the new regime and then letting it set sail into the distance. Instead, I believe we need a formal review of the implications and experience under the new pensions regime. I acknowledge the Government will monitor this. But I advise a formal review is established to report on the new pensions regime and guidance guarantee in 2020, involving external parties representing all elements of the industry working alongside the Government.

Implementing the new pension freedoms and regime is a massive challenge. But if we get it right it can only mean good things for people wanting to make the most of their savings in retirement.

A mass of contradictions

So another year of Parliament will kick off in September, and another Pensions Bill awaits us (as well as another Finance Bill full to bursting with pension amendments). Is anyone else feeling dizzy from this never-ending onslaught of changes to pensions?

We can look forward to the laying down of the rules for the new pensions freedom, as well as the introduction of the defined ambition regime – the third way, for those who don’t want defined contribution and can’t afford defined benefit.

But when laying these two initiatives side by side, it’s becoming increasingly obvious that there is no master plan behind pensions. Instead, it’s a swirling mass of contradictions, and legislation using the piecemeal effect.

Back in 2006, I distinctly remember being promised the introduction of A-day was the end of itty bitty changes and tinkering of legislation. But it’s proved to be anything but.

A few things to draw attention to.

The budget changes bring in autonomy and responsibility. It’s your money; you spend it how you see fit. But the new CDC regime is all about pooling money together (so you have no idea what’s yours and what’s not), and trusting in a higher body to give you the right amount of money at the right time in retirement. So, completely opposing views.

Next year we also get the charge cap for defined contribution schemes. Steve Webb (and others) has lamented the fact that we can only use the charge cap to control fund management charges and not total charges. The industry is in a state of worry (and rightly so) about how much the pesky transaction charges cost someone, and why they aren’t disclosed clearly and transparently.

But how much will CDC costs amount to? Or the guarantees being offered through defined ambition schemes? I strongly suspect we will never know. It seems bizarre to me that we have spent the last ten years travelling towards openness and transparency about how much your pension costs you, and now the new defined ambition regime is driving a cart and horses right through this initiative.

Will the costs fall under a charge cap? I don’t think so, unless the cap’s extended to DA as well as DC. But remember, this new regime is essentially DC. Employers’ costs are controlled – they pay a percentage of earnings (or whatever). Charges will fall to the member. It’s just they won’t have the foggiest what they are.

And the new guidance guarantee will only apply to DC schemes – not to DA or DB schemes. In a way you can understand the logic. Transfers from DB schemes to access the new freedoms won’t be allowed for public sector schemes and might be banned as well for private DB schemes. So these people don’t need guidance.

But what about those in DA schemes (indeed, if any are ever set up)? On the one hand, you could argue they should be treated the same as those in DB schemes. If there is a mass exodus of members at retirement then the pooled scheme will ‘fall over’. But I believe in freedom. People should be allowed to transfer out. It’s just the trustees will hit them hard with a market value adjustment (or whatever it’s called) to cover the scheme’s back. And that’s a tricky decision – stay in the DA scheme for the benefits you are promised (or even guaranteed), or transfer out to DC and spend your money how you want to. People will need help.

Things are happening too fast in pensions. They are not thought through. They are not joined up. There is no master plan.

Instead, politics is driving change. And that means politicians’ needs are at the centre of new developments not customers.

Life expectancy predictions should be for life

Steve Webb’s idea of providing people with a life expectancy calculator received mixed reviews. I happen to think it’s a good starting point. People really do underestimate how long they are going to live. Even if we are given tables of average figures, most of us automatically deduct at least a couple of years (for bad behaviour!).

MGM Advantage recently did a survey which found men thought they were going to die at 81, where the average is 86. And women thought they were going to die at 79, and the average was 89. So, it’s obvious most of us need a sharp prod to get a more realistic idea of how long our money has to last.

But until we get that sci-fi DNA code generator that can work out our exact date of death, we are talking about averages and statistics here. So we need to emphasise the possibilities of living longer than the average. We should be giving people the statistical possibility of them living to 90 or 100. These risks need to be drawn out. If you are aware you have a 15% chance of something happening you may adjust your behaviour and choose to cover/address that risk.

But this cannot be a one-off prediction issued to people only when they ‘retire’. Firstly, because the longer you live, the longer you are predicted to live. So, my predicted life expectancy would be greater at 75 than it would be at 60.

And secondly because things will change. Medical factors will change. Lifestyles will change. (For example a decade ago the Government began pushing companies to reduce the salt in processed foods with the result we ate 15% less salt in 2011 than in 2003.) Even the way we predict life expectancies will change.

So, the conclusion has to be people need to regularly receive life expectancy predictions.

In fact, life expectancy predictions should be for life, not just for retirement.

And that leads us onto how we deliver the original prediction and any subsequent updates. Steve Webb’s idea is life expectancy predictions should be delivered as part of the guidance guarantee. Sure, we can leave people with a calculator to revise the expectancy whenever they want. But will people really do that, and if they do, will they, as a consequence, take any different or new action?

So following this train of thought the guidance, shouldn’t be a one off event either. And when you think about it, it’s inconceivable that it would work that way. The days of people making a single (irreversible) decision at retirement are long behind us. People will need regular and consistent help to make sure their money lasts for their lifetime. However long that may be.