20th March 2014
Pensions freedom is a powerful message. And Chancellor George Osborne’s ending of compulsory annuitisation made headlines. It was an out of the hat total surprise – and it overturned nearly a century of Treasury thinking writes financial journalist Tony Levene.
But freedom is not always what it is cracked up to be. One person’s freedom can be another person’s problem – the council house right to buy reduced the supply of affordable homes to rent; and freedom brings responsibilities and duties that those given liberty may not want to embrace – the UK has been so bad at voluntary pensions forcing the state into auto enrolment.
Following yesterday’s surprise Budget attack on annuities, Danny Wilding, partner, Barnett Waddingham says: “As the dust settles on the most radical pension budget for many years, the key question we are left with is whether the majority of pension savers will actually be able to take advantage of the new flexible rules post-retirement.
“Significant numbers of high earners already use pension income drawdown options and will welcome the proposed greater future flexibility. But what about everyone else? The expenses and plethora of investment options of income drawdown are currently prohibitive for those with low to medium pension savings.
“I think the answer for many will be some kind of Collective Defined Contribution (“CDC”) pension arrangement. CDC could operate a pooled pension fund for members who may come from a number of associated or non-associated employers. One of the key advantages would be that members could stay in the pooled arrangement post-retirement and draw their retirement income from the collective fund. This means they can share in a common investment strategy, and pooled expenses, both of which will benefit significantly from economies of scale, making income drawdown a feasible solution for many more savers.
Annuities, where rates have halved over the last decade, are grossly unpopular. Returns are very low and holders might need to survive 20 to 25 years just to get their own money back. The end in 2010 of compulsory annuity purchase at 75 has only been meaningful for those well-off enough able to opt for complex “income drawdown” products. (http://www.standardlife.co.
The devil will be in the detail, however, and there will be plenty of small print before the new rules finally come into force in April 2015. There will be opportunities and traps, investment lessons and unforeseen consequences.
What was the case for compulsion?
Around since 1921, the need to buy an annuity was motivated by what many see as a patronising desire to protect pensioners – then almost all male and with a far lower life expectancy in retirement than now.
Until earlier this week, the Treasury line was effectively that if you let people take their own money, they would spend it all in one shop and then come, cap in hand, to claim means-tested benefits. This misses that on retirement, people can already take up to a quarter of their fund as tax-free cash and ignores rules on capital and savings which ensure that most people who retire will not be able to claim income support.
What will replace the annuity?
Hargreaves Lansdown’s chief executive Ian Gorham says the new rules could well spell the end for standard annuity products. Certainly, other rules have been relaxed to allow small pots to be taken as cash ending the situation where someone with, say £2,000 from a long forgotten short term employment would either need to buy an annuity producing just a few pounds a week or amalgamate it into a Sipp (self invested personal pension). And the end of compulsion leaves those at the extremes – rich and poor – untouched. The wealthy have income drawdown while those on the lowest levels have state benefits.
But who or what will provide a regular income to those in the middle? Only a small proportion have the knowledge or inclination to manage their own money. And even fewer want to calculate their own and their partner’s mortality – how long the money will have to last. One solution could be “annuity-lite”, a series of short to medium term guaranteed incomes which avoid the “once and for all” lock-in with a traditional annuity. A number have been tried but failed to achieve the necessary volume for success. Whatever their faults, annuities provide certainly provide certainty.
What will be the tax implications?
The UK pension deal is tax-free going in, taxable coming out. After the 25% tax free lump sum, withdrawals will be taxed at the holder’s “marginal rate”. That is likely to mean that someone with an existing £15,000 income who takes a £100,000 pot in its entirety will pay tax as if they earned £90,000 – £15,000 plus the taxable 75% of the pot pushing them into higher rates although staggering withdrawals will help.
The Treasury may gain long term from Inheritance Tax (IHT) if more pension pot money stays with holders until they die. IHT is also levied on Individual Savings Account (Isa) assets.
What might the unforeseen consequences be?
Pension pot withdrawals could further fuel the over-heated (in some areas) housing market. Many will re-invest in a buy to let property. Others will gift the money to children so they can clamber on the housing ladder.
And it could be open season for scam merchants and boiler room operatives. Armed with “can’t fail high income” concepts such as land-banking, coloured diamonds, wine or carbon credits – to name just a few – , they may well try to persuade older people, already their number one target, to hand over pension cash to them.
What about wider investment considerations?
The share price collapse at Partnership Assurance – down from a post IPO high of 540p last June to around 300p before the Budget and now 128p – is a warning about over-exuberance on a one trick pony. More widely based insurers such as Legal & General suffered less. Partnership specialised – profitably – in impaired life annuities which give higher rates to those who smoke or have suffered serious illness. But analyst Barrie Cornes at stockbrokers Panmure Gordon, says that “while the abolition of compulsory annuity purchase is a massive change to the industry it does not mean the end of annuity product sales”.
“Share prices have been hit hard to the point where we think the market is assuming no new annuities will be written going forward,” he said. “We think the product will still be acquired given the need for security of income in old age.”
If the new freedom is to be more than just on paper, falling annuity sales will leave the Treasury needing to find a new buyer for the certainty of long term gilts.
What about other countries?
Australia is one of many countries where annuities are voluntary. Now academics there argue that “a retirement income system with some form of compulsory annuitisation may potentially be a way to ensure Australians use their superannuation balances for their intended purpose: to fund their retirement.” http://ro.uow.edu.au/cgi/