Pension freedoms - the definition of 'success'
I was intrigued to see a number of recent media events and articles asking similar questions along the lines of: “Two years in: have the pension freedoms been a success?” It got me thinking and I soon realised that I was not sure that I really understood the question. After a bit more thought I decided that the key to this question was the meaning of the word ‘success’.
When the pension rules were relaxed back in 2015, I divided the ‘retiring’ world into three groups, based on size of the fund (and other retirement assets). Perhaps my starting point is to go back to those divisions.
- Savers with small fund values (i.e. £0 - £50,000). The pension freedoms can benefit those who have small, non-life-changing sums that would previously have been used for drawdown or annuity purchases. These can now be used to provide greater utility if used to pay off a loan or take a holiday for example (and provided they understand the tax rules and are aware of pension scammers).
- Savers with large fund values (i.e. >£750,000). The pension freedoms should be a real benefit as they give income flexibility, tax planning opportunities and allow interaction with other assets.
- Savers with medium-sized fund values, (i.e. £50,000 - £750,000). This is the difficult one for me and it is tough to put an exact number on this group. This is the ‘squeezed middle’ – those people who, on average, hold more in defined contribution schemes than they do in defined benefit schemes and possibly still have kids at home. There is a real call for a guarantee on a potentially limited set of assets – their pension is really to replace their income when they retire.
My next layer for consideration is access to financial advice.
- For clients with small funds and a one-off spend, perhaps advice is not needed. As mentioned above, for me, it is about having an understanding of the tax rules and an awareness of scammers.
- For large funds, advice can pay real dividends. The example I often use is one put to me by an adviser – his client wanted an income payment of £200k net for a flat for his son; the adviser worked out the tax on this and the client took out a mortgage instead. In this example the pension freedoms had invited a chance for efficient financial planning.
- Again, the middle group is the difficult one. Research consistently shows that people underestimate their life expectancy and, in many circumstances, they want a guaranteed income. Cash flow planning, volatility, safe withdrawal rates and annuity purchase are all key and this, to me, is a requirement for financial advice.
So, are we getting any closer to what pension freedoms ‘success’ means and how we measure it? Let’s now look at it from a perspective of what individual success and policy success would look like.
Individual success is in making sure individual needs and goals are met, and for advised clients with small one-off transactions or large funds there could indeed be success. The squeezed middle could also perhaps achieve beneficial outcomes (success?) with an adviser.
However, I think there will be situations where people do not take advice, are tempted by reports of ‘flexibility’, do not understand longevity risk and end up with much less beneficial outcomes. In Australia this has manifested as either people running out of money or of being scared to take enough to achieve their desired lifestyle (‘reckless conservatism’).
To be a ‘success’ a pension freedoms regime needs a strong annuity market and a removal of the stigma that seems to have become associated with annuity purchase. It also needs an appreciation of the value of financial advice and improved access for consumers to take such advice.
What do we want from policy to make it a success? Well, the Government making the policy wants a bit more tax – I think that box has been ticked with the figures made available at the last Budget! It also wants, or at least I assume that it wants, the flexibility to be understood, not just by those reaching retirement but also by those thinking about pension saving in the future. However, the short-termism of UK politics can often be a barrier to achieving measurable outcomes, as can the rebuilding of the rest of the system.
The pension freedoms regime can be a success, but only if there are convincing incentives that will encourage people to actually save a decent amount of money for retirement in the first place!