In this third article based on in-depth research by JLT EB into ‘under-saving’ in the UK and the role of the workplace, we consider, the impact of the 2015 ‘pension freedoms’.
Our insights into these changes - described as the most fundamental reform in a century - take into account some of the lessons that can be learned from other countries where there is no effective requirement for pension savers to buy an annuity at retirement.
PENSION FREEDOMS ARE A FURTHER INCENTIVE TO SAVE
Our in depth research observes that the 2015 reforms, allowing savers to use their pension pots entirely as they wish, has resulted in pensions becoming more like other forms of savings. In particular, pensions are no longer confined to providing an income in later life; they now have much greater application in other areas such as debt repayment and succession planning. Freedoms has enhanced the ability for pension planning to liberate income as well as generate it.
We believe that the pension freedoms have made pension saving more attractive and increased member engagement.
Of course, the freedom to choose also means the freedom to choose unwisely. However, the 2017 Financial Conduct Authority (FCA) retirement outcomes review found that pensions were not being squandered (though it did raise concerns about poor choices among those who did not receive advice).
Moreover, as we said in the first article in this series, the pension freedoms may help make government recommended income replacement rates (e.g. a pension of 2/3rds of pre-retirement income for a median earner) more attainable.
HMRC statistics show that since the introduction of the pension freedoms (Q2 2015), the number of flexible pension payments increased from 121,000 to 585,000. Total flexible payments from pensions now exceed £21,680 million.
BUILDING ON THE REFORMS
The October 2018 bulletin from the Government Actuary’s Department comments on the pension freedoms and observes that –
“Pensions Freedom has led to vast changes in how consumers access their pensions, with huge reductions in annuity purchases and greater flexibility in access. Whilst product innovation has been slower than expected the incentives to innovate are growing and should result in more options for consumers in future.”
Automatic enrolment (A-E) has demonstrated how it is possible to harness inertia effectively. Millions of savers have been added to workplace pension schemes as a result of AE but product evolution is limited, with few providers demonstrably tackling the problem seriously
There is, in our view, now a case to be made for default decumulation paths, ‘nudging’ savers in the right direction when it comes to decumulation and in particular income drawdown.
Drawing regular income from pension savings is not like buying an annuity. It requires much more sophisticated planning with the potential need to adjust the decision originally made as the time goes by. At the moment, the mass market does not willingly appoint – and pay – advisers. So, default decumulation paths into drawdown would help savers who do not access individual advice. It would also address the dangers associated with cognitive decline due either to old age or an illness such as dementia.
Whilst on the subject of ‘advice, as DC pension pots continue to grow and more of us become almost entirely dependent on DC savings in our later life, assistance will not just be needed ‘at retirement’.
The guidance available from the soon to be replaced PensionWise, for those aged 50 or over, may be ‘too little too late’ for many individuals. So, the ‘age-limitations’ of PensionWise / its successor could be addressed by a ‘mid-life MOT’, facilitated by employers. This check-up could help employees keep their retirement plans ‘on track’ because, where gaps are identified, there will still be time to fill them!
LESSONS FROM ‘DOWN UNDER’ AND ‘ACROSS THE POND’
Calls for more help to be given to members at the point of retirement are not unique to the UK.
‘Down under’, in Australia the ‘Super System Review’, chaired by Jeremy Cooper, found that the Australian retirement income product market was under-developed. It recommended requiring trustees to offer retirement products and to pro-actively offer advice to members. The Australian government has since said that it would legislate to allow trustees to help guide members at retirement and improve outcomes for retirees.
Retirement product development is expected to be a fertile ground for innovation in the superannuation industry as more and more Australians move into the retirement phase with increasing account balances.
Looking ‘across the pond’, to the US, where more than 94 million Americans are covered by DC plan accounts, early access to pension savings is possible.
Plan withdrawals are possible before a job change or retirement and can be broadly classified into two categories – hardship and non-hardship withdrawals.
When changing jobs or retiring, DC plan participants have the choice of preserving their savings for retirement (by retaining them in the plan or rolling them over to another DC plan) or taking a cash lump sum (and spending or investing it). If they choose to roll over their savings to an Individual Retirement Account or another qualified retirement plan, participants avoid paying taxes on the accumulated balance. If participants spend the lump-sum distribution or invest it in a taxable account, they incur a possible income tax liability.
Allowing early access to pension savings or, alternatively, introducing other forms of workplace savings (such as ‘LISAs’ or ‘ISAs’) alongside company pension schemes is very topical at the moment. The reason for this is that it helps to overcome reservations that some individuals may have in respect of access to pension savings. In other words, concerns that money put away for later life is not usually available until age 55 at the earliest.
Flexibility of access has certainly brought pensions to life for many. But with rights comes responsibility and, ultimately, that responsibility lies with each of us as individuals. This is perhaps the biggest message that DC heralds, and a message that still hasn’t yet fully dawned on many of us.
We will return to the issue of access to pension savings in the next, and final, article in this series, when we consider the recommendations from our detailed research.
For more information on the issues raised in this article and how they may be impacting your people and business, contact John Wilson, Head of Technical at email@example.com.