Pension freedoms have given savers more choice than ever. Louise Farrand finds out how retirees have been spending their money – and if they’re making the right decisions
Freedom and choice: it sounds so good in theory. Consumer champions welcomed the government’s reforms, announced in the 2014 spring Budget, that gave people much more freedom over how they can access their pension savings, and abolished the requirement to buy an annuity.
The liberalisation was also popular among the public. Research by the National Association of Pension Funds (which has since rebranded as the Pensions and Lifetime Savings Association) showed that 81% of consumers welcomed the freedoms.
But others warned that, left to their own devices, savers would run out of money. Consultancy Mercer went so far as to downgrade the UK’s rating in its 2015 Global Pensions Index from a B to a B minus, stating it was “primarily due to the removal of any requirement for retirees to purchase an annuity”.
Freedom and choice places the reins back in savers’ hands, making it more important than ever for HR managers to educate them on their options. So what are employees doing with their plethora of new choices – and how are these choices reshaping savings propositions?
The choice is yours
When chancellor George Osborne first gave savers the flexibility to take their pension savings as cash, buy an annuity, or put their money into drawdown, many pensions pundits predicted they would take the money and run.
Wild stories about how people were spending their money abounded. The Sunday Times reported that one retiree had splurged his pension on a Routemaster bus and another on a mail-order bride. The Pensions Advisory Service reported some callers had told their advisers that they want to spend their pension savings on breast enlargements and facelifts.
Today, Richard Parkin, head of pensions and retirement product at Fidelity Worldwide Investment, reports that quite a lot of people are using their money to buy their former spouses out of holiday homes.
That said, Parkin and most others agree that so far, the much-predicted rush to cash out of pensions has not materialised.
In fact, it’s had the opposite effect, says Kate Smith, regulatory strategy manager at pension provider Aegon.
Smith reports 20% of people actually have decided to save more into their pension pots as a result of the freedoms. “People seem to be more confident about putting money in, because they are more confident about getting it out again,” she explains. Aegon has also witnessed an increase in people checking their pension funds’ investment performance online.
“We haven’t seen a complete stampede to cash out,” says Parkin. “As of the first six months, we’ve seen about 6% of people who are eligible wanting to take cash – so that means 94% of people did nothing, which is quite positive.”
However, of the people making enquiries about their pensions, a high proportion are interested in taking the cash, Parkin reports. Where people are taking cash, there is a split between them taking it all and taking the tax-free lump sum and leaving the rest where it is.
Where people are taking all their cash, about half of those pension pots were relatively small: worth £10,000 or less. Parkin says: “The average was about £3,500.”
Most commentators seem relatively sanguine about savers cashing in small pots. But John Lawson is more concerned. Lawson, who is pension provider Aviva’s head of policy, says: “The worry for me is people will take their pots too early. The majority of people who are taking cash are between 55 and 60. Although they may only have £10-15,000 in their pots, that money is now gone. In today’s money, that could be £35,000 by the time they reach 65 or 70.”
Back to the drawing board
Meanwhile, statistics from the do-it-yourself investment platform Hargreaves Lansdown show a sharp increase in the popularity of drawdown. The statistics show that two years before pension freedoms, just over 10% of clients opted to take their pensions using drawdown. Six months after pensions freedoms, the proportion had leapt up to 75%.
Smith reports a similar leap at Aegon, where the value of assets customers have in income drawdown has gone up by a dramatic 88% since last year.
She cautions: “The big risk is that people will take a flat rate out of pensions, rather than staggering their money according to their needs at various points in retirement. If they don’t understand that, there’s a risk they could run out of money.”
Savers’ choices vary depending on the amount of money they have built up. Rob Booth, director of investment and product development at NOW: Pensions, reports that most of the mastertrust’s members are taking their pots as cash.
That’s to be expected, considering how NOW: Pensions was created for auto-enrolment, and so members’ pot sizes are only a few hundred pounds at the moment. “We project that for the next couple of years, members will still take cash at retirement,” says Booth.
As pension pots get larger, Booth says NOW: Pensions will explore the idea of “some sort of drawdown structure”, or perhaps allow those retiring to stagger their lump sum withdrawals to mitigate adverse tax consequences.
The Financial Conduct Authority recently released its own figures on consumer trends post-freedom and choice, aggregating data from a number of different providers.
The report reveals that 178,990 pensions were accessed by consumers between July and September 2015 – a 13% drop from the 204,581 pensions accessed between April and June 2015. In all, 120,969 pensions were fully cashed out in the quarter.
The FCA revealed that 88% of full withdrawals involved pots worth less than £30,000. Customers with larger pension pots were more likely to have taken advice before withdrawing their money.
At the same time, however, people who chose to access their savings were staying with their pension provider on the whole, particularly if they bought an annuity (64% of people who bought an annuity stayed with their existing provider).
It meant the report left experts concerned that savers could be withdrawing significant funds without shopping around or appreciating the full implications of their actions.
Claire van Rees, partner at law firm Sackers, says: “This trend reinforces longstanding concerns, exacerbated by the introduction of the pension freedoms, that many people are not accessing the information or advice they may need to make informed decisions about using their retirement savings.”
The Pensions and Lifetime Savings Association surveyed some of the earliest savers to take advantage of the pension freedoms and reported some worrying misconceptions.
For instance, of the savers they surveyed who expressed an interest in drawdown, 53% believed this option would give them a guaranteed income in retirement.
“The main concern for employers is making sure that everyone can access support,” says Roger Breeden, UK DC & savings product leader at consultancy Mercer. He says that pension fund trustees tend to be more aware than employers about the cost of savers moving their money out of preretirement investment products into drawdown.
“Educating people from the age of 45 is essential,” says Lawson. “We try our best to persuade people to think about it and speak to Pension Wise before they take their money as cash.”
Lawson also mentions that Aviva produces a great deal of educational material for savers, including a newsletter that is read by 350,000 pensioners. HR managers who are customers may find it useful to request this material, via their consultants, to pass on to members.
More than a pension
Savings are evolving fast. Having already made pensions more flexible, the government is considering whether pensions’ tax treatment should be changed to bring them in line with Individual Savings Accounts (ISAs).
The question now is whether savings will become more integrated. Some HR managers’ thoughts are already turning to the products that are on offer to support a more holistic approach to saving in the workplace.
Corporate platforms were much discussed in the UK a few years ago. These platforms allowed savers to see their finances in the round, combining ISAs, pensions and other benefits in one online portal. Some HR managers, especially those at larger companies, embraced them. However, others were put off by cost; discussion gradually dwindled. The pension freedoms may give these ideas a new lease of life.
“We are certainly seeing more interest in integrated ways of saving as tax relief is continuing to be squeezed,” says Breeden. “Companies are setting up plans to help support higher-earning individuals. Clearly a pension scheme still has good tax benefits for people who can keep their money tied in, but where those tax allowances start to bite and where people want to access funds in the shorter term, then additional forms of saving in the workplace will really go down well.”
Fidelity’s Richard Parkin agrees that a holistic view of savings is the future. “Our vision is being able to talk to a customer about all their income sources, whether that’s defined benefit, the state pension, an investment portfolio, defined contribution savings, whatever it is, and look at that against their retirement goals.”
As a fast-growing pension scheme, NOW: Pensions will surely have the economies of scale necessary to offer its members additional types of saving in the future via an integrated platform, won’t it?
“It’s exactly the sort of thing we’re looking at as a workplace financial services provider,” says Booth. However, he warns that the first priority should be to get members interested in the idea of saving.
Even the National Association of Pension Funds’ recent rebrand as the Pensions and Lifetime Savings Association reflects the industry’s recognition that lifetime savings won’t purely come in a pensions wrapper.
“If the world is changing, we need to change too,” said PLSA’s chief executive Joanne Segars, speaking at the organisation’s press launch last autumn. It’s advice that the canny HR manager would do well to follow when constructing a 21st-century savings package.