DESIRED RETIREMENT AGE 65
ANNUAL PENSION TARGET £46,000
MONTHLY SAVINGS REQUIRED £3,080*
Why did George Osborne decide to announce new pension freedoms, which allow members of a money purchase Defined Contribution (DC) pension scheme aged 55 or over to access their whole pension pot, in the 2014 Budget? And why, in March, did the chancellor put an end to restrictions on the sale of annuities, allowing people to cash them in without incurring the current punitive tax penalties? Hopefully the changes will encourage more people to save more for their retirement and will stimulate innovation and the development of new pension products. But one wonders whether there is an ulterior motive.
“There’s a pretty transparent political agenda to unlock billions of pounds of pension money just a month before the general election,” Tom McPhail, head of research at pensions and investment specialist Hargreaves Lansdown, told The Observer in January. “The policy may be a good idea, but the timing is unashamedly intended to buy votes.” One of McPhail’s chief concerns, shared by a number of other well-informed industry insiders, was that pension providers simply have not had enough time to prepare for the new system.
But that might not be the biggest problem related to the new freedoms. Osborne initially pledged that those affected by the changes would be offered “free, impartial, face-to-face advice”. He quickly backtracked, explaining that he actually meant “guidance”: an interaction with someone not regulated to provide financial advice, but simply to clarify the available options. The changes have the potential to affect millions of individuals and their families yet there are fewer than 30,000 FCA-authorised advisers – not a lot to go around. In some cases, the size of the pot or the specific financial circumstances of the individual may make it easy to determine the right course. For others the decision will be very complicated and there are some concerns that some people will be vulnerable to fraudsters selling bogus investments.
“These flexibilities and freedoms are good, but make things even more complicated,” says Malcolm McLean, senior consultant at actuary Barnett Waddingham. “People could get this horribly wrong, then have to live with the consequences for the rest of their lives. They need help.”
There will be two sources of guidance available from the government’s new Pension Wise service: face-to-face appointments, hosted at Citizens Advice Bureaux (CAB) across the country (at the time of writing only the first 44 in England and Wales had been announced); and telephone sessions offered by The Pensions Advisory Service (TPAS).
But these resources may not fulfil Osborne’s pledge to provide universal face-to-face guidance, because many people will be unwilling or unable to travel to the nearest venue. “I know from my own experience that trying to get information over the phone to anybody who doesn’t understand pensions is going to be very difficult,” says Claire Trott, head of technical support at pensions services provider Talbot & Muir.
In late January, in a move that may or may not have been inspired by government agitation, the Financial Conduct Authority (FCA) wrote to CEOs of pension providers proposing they form a “second line of defence” to help prevent individuals making self-defeating decisions. Providers will now be required to ask scheme members a series of lifestyle questions relating to their proposed course of action, then issue “risk warnings” if plans appear unwise. “This is a complete U-turn, because at one point the government was saying it didn’t want providers involved,” says McLean. “It indicates that the government doesn’t think that the independent guidance is going to be good enough.”
Nonetheless, demand for guidance could be very high and this is bound to have an impact on ICAEW’s members in practice. Martin Tilley, director of pensions technical services at SIPP specialist Dentons, points out that the numbers of retirees seeking guidance – expected to be about 300,000 per year – will be boosted by those who could have retired since the Budget but deferred a decision to take advantage of the new freedoms. “I think there’s going to be a huge problem getting appointments during the first few weeks,” he says.
A spokesperson for the Treasury disputes this: “The government is committed to ensuring that a sufficient number of trained guidance specialists will be in place for April. We are working closely with stakeholders to predict and continually monitor demand... The government has plans in place to deal with any initial surge of demand.”
Naturally, once someone has secured an appointment, they will want guidance by someone armed with the necessary expertise. The guidance delivery jobs advertised by TPAS were for individuals with “experience of working in or with pensions” and knowledge of relevant legislation, who would earn around £30,000 for permanent and fixed-term positions. But the CAB service job description simply states that some knowledge of pensions issues would be an advantage, while salaries range from £18,000 to £24,000, for fixed-term contracts, to be extended if funding permits. These differences can be explained in part by the fact that CAB is a charity and is recruiting nationwide, while TPAS is recruiting in London. But McLean recalls Osborne promising that people would have access to “expert” guidance. “I don’t think CAB, with the best will in the world, is going to deliver that service.”
John Gaskell, financial planning and advice manager at ICAEW’s Financial Services Faculty, believes the UK could learn a great deal from other countries’ experience of pensions freedoms. In Australia, government-backed superannuation pensions have allowed individuals to access retirement savings from the age of 55 for more than 20 years. A recent Financial System Inquiry, led by banker David Murray, revealed that about 50% of Australian retirees withdraw pension savings as a lump sum. Of this group, 25% had spent the lot by the age of 70. The report also revealed that many retirees who do not do this are instead spending their money in an overly frugal way, lowering their living standards and thus, to some extent, damaging the Australian economy.
The report concluded that Australians’ standards of living in retirement would be increased by more risk pooling, offered through the development of guaranteed lifetime income solutions that manage longevity and investment risk through a pooling element. In other words, as Michael Davidson, senior policy adviser, superannuation, at accountancy firm CPA Australia, puts it: “You’re coming from where we want to be – and vice versa.”
CPA advocates greater use of products like deferred annuities, to which individuals can move at 75 or 80. “Our biggest issue is addressing longevity risk,” says Davidson. “People need to understand that while accessing your lump sum may provide immediate benefit you still have to have income to live on in retirement.” This is a message that should resonate in the UK too.
Would it not have been more sensible to introduce the new UK regime more slowly? “We have consulted extensively with industry on the reforms,” says a Treasury spokesperson (a statement sceptics might describe as chutzpah: consulting people after a policy has been announced being rather different from doing so beforehand). “Some firms have already announced new products for April 2015 and others are planning to do so in the near future,” the spokesperson continues. “If a particular pensions scheme fails to offer suitable products... customers have the right to transfer savings to a different provider.” Such action would be supported by guidance “delivered to rigorous FCA standards” that “empowers and educates people so they can make their own, informed choices and confidently engage with the pensions industry”. Well, the sceptics might respond, let’s hope so.
We put the same question to Mark Hoban, a chartered accountant and Conservative MP for Fareham in Hampshire, who has served as a minister in both the DWP and Osborne’s Treasury during the current parliament. He is stepping down as an MP in May, but is still reluctant to shed any light on how long ago the pensions freedoms were first contemplated at the Treasury.
“If you look at some of the measures we took at the start of this parliament, such as ending compulsory annuitisation and introducing new drawdown products, you can see that we were always moving towards these types of changes in the pensions system,” he says.
Nor does he accept that it would have been preferable to give the pensions industry more time to implement the changes needed. “You would have had slow progress,” he says. “The fact that insurers are struggling to keep up is a reflection on them not investing enough in their systems.”
Hoban thinks Pension Wise represents “a good start” for the provision of guidance, but would like to see the introduction of services based on a concept he has devised: the Retirement Saver Service, a digital service that would support consumers through pension planning and retirement by providing a single platform through which they could review all pension savings from state and private sources. Tilley has an alternative suggestion: a voucher scheme enabling individuals to draw, say, £150 out of their pension pot to buy an hour with an IFA for a preliminary discussion, up to three years before retirement.
In the shorter term, Margaret Snowdon, chairman of the Pensions Administration Standards Association (PASA), and a director at JLT Group, suggests the government expands the range of organisations given official licence to provide guidance to retirees, to include accountants. They would be particularly well-placed to advise clients on how the new pensions rules impact tax planning, around inheritance of pensions savings, for example.
When asked whether in future accountants might be given some responsibility for providing guidance, the Treasury spokesperson responds that “providers of the Pension Wise service must always meet the government’s requirements that they must be free from any actual or potential conflict of interest in order to safeguard the impartiality of guidance provided” – which seems to suggest accountants will not be providing officially-sanctioned guidance any time soon, but does not alter the fact that they could provide clients approaching retirement with valuable support. Accountants could do this by building a strategic relationship with a trusted IFA, and seeking a Designated Professional Body licence (see box, right).
RIGHT OF TRANSFER
As for those still some distance from retirement, what principles should determine their retirement saving strategies? Simply getting into a basic auto-enrolment pension scheme is a useful first step, but it’s important to bear in mind that contribution rates in these schemes are currently very much lower than would be needed for most members to enjoy a comfortable retirement. Higher contributions or private pension provision will supplement income coming from an occupational DC scheme and the state pension. McLean says an old rule of thumb is a good starting point: save half your age as a percentage of your annual income. So if you are 24, save 12% of your income (including the employer’s contribution) – or as close to that as you can afford.
Whatever your age, if you are in a Defined Benefit (DB) occupational scheme you may want to consider exercising your statutory right to transfer to a DC scheme, from where you can access your pension pot. Transfer values are based on what might have been in the fund at retirement, with this figure then reduced at an assumed rate of investment return as it is rolled back to the present day. Because gilt yields are currently very low, that reduction is minimal, meaning transfer values are unusually high, making this a tempting option in the right circumstances.
As things stand, it will not be an option that is available to those in “unfunded” public sector pension schemes. This may cause some disquiet, says McLean, even though it is likely to be in the best interests of public sector employees to stay inside their relatively generous schemes. There is, he stresses, still much to be said for a good DB scheme: “A final salary scheme really is a good deal – you need to think very carefully about moving out of that.”
This just underlines the importance of expert guidance or advice. Ultimately, ICAEW’s Gaskell would like to see the provision of guidance to retirees forming part of a broader long-term programme to improve financial literacy within society. “It’s all about confidence and empowering individuals,” he says. “Unless people have confidence that they can trust the government, the Treasury and the industry to deliver something that’s in their best interests you’re never going to close the savings gap.”
*The monthly saving required to achieve a target pension depends on a number of assumptions: the individual is a male; they intend to use their savings to purchase an annuity product that is inflation-proofed income payable for life, and their spouse’s pension (at half the rate) is payable on death; the future price inflation is expected to be around 2% per annum on average; he can invest his pension savings to achieve a return of 4% per annum before he retires; he will also receive a state pension equivalent to £155 per week (£8,060) in today’s terms, and annuity rates in the future will be broadly similar to those available in the market today.
One way accountants can help clients to make the best use of the new pension freedoms would be through creating a strategic alliance with an IFA and seeking a Designated Professional Body (DPB) licence. Such an alliance and a DPB licence will help accountants prepare a financial plan for clients to explain how pensions can be used as an appropriate tax mitigation medium. The IFA can then give specific product advice and arrange the necessary transactions. As Alan Hind, senior manager, quality assurance, professional standards at ICAEW points out, there are over 10,000 member firms that haven’t got a DPB licence that may be missing out. “The compelling reason for getting a DPB licence is to provide a better financial planning service to clients,” he says. “The government’s pension reforms are an opportunity for chartered accountants as trusted advisers to demonstrate how they can add value. Forming a strategic alliance and taking a DPB licence should help chartered accountants to make the most of business opportunities.”
A DPB licence enables accountants to:
explain and evaluate advice the client receives from a financial adviser;
identify unsuitable advice from the financial adviser; and
endorse suitable advice.
They can’t discuss merits of specific investments; that is a regulated activity still requiring FCA authorisation.