Pension freedoms two years on: five key trends
The world has changed beyond all recognition in the past two years. The UK has begun what is likely to be a long and tiring journey towards exiting the European Union. Theresa May has replaced the vanquished David Cameron as Prime Minister, and is now seeking a mandate of her own after calling a General Election on 8 June.
And let’s not forget that Donald Trump – yes, former Apprentice host Donald Trump – has become President of the United States.
Away from the shifting of political tectonic plates, dealing with the opportunities and risks posed by the pension freedoms has been front and centre for advisers and paraplanners since April 2015.
Here, I look at some of the key trends beginning to emerge from former Chancellor George Osborne’s radical redrawing of the retirement landscape.
- Drawdown replaces annuities as the default retirement option
- Number of policies accessed for the first time beginning to stabilise
- Vast majority of pots accessed are fully withdrawn…but that’s not necessarily a bad thing
- Around two-thirds who enter drawdown take regulated advice
- Around a third of those taking regular withdrawals took out more than 2% in Q3 2016…but is this sustainable?
Prior to the introduction of the pension freedoms, most savers were shoehorned into annuity contracts which were often ill-fitting. The reforms have shaken the retirement income market to its core, and now we see drawdown sales outstripping annuity sales by roughly 2:1.
The attraction of drawdown is obvious, with savers and their advisers able to tailor retirement strategies to meet individual needs. Pensions have also become extremely efficient IHT vehicles and can be passed on tax-free where the saver dies before age 75, or at the recipient’s marginal rate otherwise.
We expect the debate to now shift to this part of the market, and specifically the sustainability of drawdown withdrawals – particularly among those who are not taking financial advice.
There was an inevitable bulge in flexi-access withdrawals in the initial phase of the pension freedoms as those who had delayed their retirement income decision following the 2014 Budget announcement moved to access their pot.
While over 218,000 pots were accessed for the first time in April-June 2015, the figure has tended to be somewhere between 130,000 and 160,000 since then.
Since the freedoms were launched most savers who have accessed their pension for the first time have withdrawn the entire pot. This might explain why the Government’s coffers have swelled far more than initially anticipated – pension withdrawals are taxed as income, so bigger withdrawals generally means more tax for the Treasury.
However, this isn’t necessarily a cause for alarm. The vast majority of full withdrawals are from very small pots (below £10,000), which in many cases will be a perfectly sensible decision – particularly if those people have other savings elsewhere.
Retirement income decisions are complicated, with savers having to build an investment and withdrawal strategy based on a number of uncertainties - not least how long they might live for. Advice can therefore be extremely valuable, so the fact most people entering drawdown are speaking to an adviser first is good news.
The Government must not rest on its laurels here, however, and it is worth noting take-up of advice in the annuity market – where the buying decision is irreversible – sat below 50% in Q3 2016.
Policymakers are hoping to boost the number of people taking advice and the affordability of advice solutions through the Financial Advice Market Review, although the jury is still out on how successful this initiative will be.
Sustainability of withdrawals remains arguably the key issue when it comes to the pension freedoms. On the face of it, the fact around a third of people in Q3 2016 withdrew more than 2% of their pot – suggesting a large proportion are withdrawing more than 8% a year – is a significant cause for concern.
However, this data does not take into account other sources of income, whether the person has multiple pots or overall wealth. Without this information it is impossible to say whether the withdrawals savers are making are sustainable or not.