Published 20 November 2017.
A one-pager from The People’s Pension about the DWP Select Committee review of Pension Freedom.
1. What is Pension Freedom
Prior to 2015, individuals hitting retirement age with more than a minimum sum in their pension pot were in effect required to purchase an annuity with the bulk of their retirement income (25% of their pension pot could be withdrawn as a tax free cash lump sum). An annuity is a regular income provided throughout someone’s retirement provided by an insurance company. Since Pension Freedom, individuals are free to access their pension pot at any point from the age of 55 and can do what they wish with the sum. If they access all of it as a lump sum, they pay tax at their marginal rate. Accessing the whole sum may take them into a higher tax bracket in that year.
2. What is the problem with Pension Freedom
The concern with Pension Freedom is exercising it in a way that will efficiently deliver a regular income in retirement requires actuarial, economic and investment skills that few people possess even if they do not succumb to common behavioural biases. It is likely to lead to a significant proportion of people under saving and running out of income in retirement and a significant proportion of people oversaving and not enjoying as good a living standard as they might have done. It has also provided an opportunity for scammers to separate people from their lifetime savings. An additional consequence of early access to lump sums is that large numbers of people have paid substantial additional tax which would otherwise have gone towards their retirement income.
3. Are there any advantages to Pension Freedom
Freedom and choice can be seen as a necessary act of destruction. It meant that people were not forced to buy annuities at the age of retirement when (i) annuity products had been rendered poor value by the low interest regime adopted to cope with the Global Financial Crisis (ii) rising longevity meant that a combination of drawdown and a later life annuity probably represented better value than an annuity for most people; and (iii) there was a lack of protection from the regulator for people who rolled over to an annuity direct from an insurance company with which they had saved. However, freedom and choice was an incomplete reform, because it did not require the putting in place of default at retirement vehicles which were the necessary complement to mass automatic enrolment pension saving schemes based on inertia.
4. What is the evidence from the UK?
People are emptying pension pots and either spending the money or if saving it, placing it in bank accounts which is an inappropriate vehicle for trying to generate a retirement income. We have sponsored research following a group of people since 2015 as they grapple with pension freedom and would be happy to organise a presentation.
5. What is the government doing about the problems?
The government has so far relied on making pension guidance available through Pension Wise. Perhaps 10% of those eligible have used the service. The government is also encouraging the development of the pension dashboard which is likely to expand the number of people who engage with pensions. However, the government needs to do more for the majority who will not engage and need a reliable product on which they can fall back. The FCA has begun consulting on default retirement products, but regulatory rules need to change before these can feasibly be offered to the mass market.
Last updated: 20 November 2017