Posted: 19th January 2015
2015 will surely bring new regulatory challenges and following recent announcements by George Osborne, pension reform is very much in the public limelight.
The pension reforms include the abolition of the 55% tax charge levied on unvested pensions for people who die after age 75 and the ability to take defined contribution pensions as a lump sum.
With such significant changes coming into force in April 2015, firms need to be mindful of how they may be affected, and they must ensure that their customers are just as aware. We shall first address several background issues that need to be understood before digesting the impact these latest reforms will have.
The death of annuities!
After the Chancellor’s proclamation that unvested pensions should be used “like a bank account” accessed “as much or as little” as pensioners want; many expect the demand for annuities to decline significantly. Early data from Just Retirement, who saw their total annuity sales fall 48% in the three months to 30 September 2014, certainly indicates this is a likely trend, particularly when viewed alongside Partnership announcing that individual annuity sales have dropped by 74%.
However, forecasting the demise of the annuity is possibly rather premature. Whilst one cannot ignore the reduced sales of annuities, they may become more desirable later in life. Individuals may want the immediate benefits of being able to access their whole pension pot upon retirement, yet they may then consider an annuity to cover their essential needs for later life. To write off the future of annuities would be short-sighted, as their importance to pensioners could still be vital in respect of covering essential needs where there is likely to be less capacity for income fluctuations.
Apathy vs education
One of the most noteworthy areas of discussion affecting pensions and the new reforms relates to the subject of behavioural economics. The government is going to offer free guidance for all people approaching retirement from April 2015. Although the providers of guidance are now known, and it has been confirmed that guidance will be available face-to-face, by telephone and through web chats, many questions remain unanswered, for example it is unclear how many guidance sessions people will be entitled to, or the length of the sessions.
There is a view that an increased apathy towards the financial sector may lead to individuals refraining from taking pensions guidance which could adversely impact their future decisions. In addition, based on the fundamentals of behavioural economics, it is counter-intuitive to expect increased choice (and complexity) for investors in the area of retirement options to drive better customer outcomes.
The new reforms are complex to say the least. The potential tax an individual could incur through drawing out money from a pension pot shows that a lack of advice could result in material customer detriment and seriously affect the money an individual has to live on. Whilst the first 25% of a sum withdrawn is tax free, the remaining amount removed is taxed at the marginal rate of income. The reforms do allow greater access and a better deal for pensioners, but one must be aware of the regulations before making decisions.
Why the need for guidance?
An additional social factor firms need to account for is the UK’s ageing population, notably after Partnership Chief Executive Steve Groves called life expectancy estimates “useless”, prompting worries that pensioners may inadvertently run out of money. An aging population that is living longer highlights the need for comprehensive guidance for people looking to ensure that they do not outlive their retirement funds. As people do live longer, it is likely that many could suffer a reduction in their cognitive functions, impairing their ability to manage their retirement funds effectively which certainly needs to be considered in the advice process.
Traditionally pensions were not particularly mobile. Individuals stayed with one company before retiring, meaning that their pensions also remained relatively static. However, the modern workforce is far more mobile, changing jobs more regularly, moving their pensions with them. When you add this to the flexibility to draw pensions from age 55, there is no longer a formula for dealing with an individual pension, so taking guidance will be the minimum a pension holder should do. For many, it may be that the guidance is simply that “you should take advice”.
What is clear is that the budget announcements have shaken up the pensions sector; underlining the need for education and support for people prior to taking their pension benefits, to help them select the most appropriate solution. Firms should take note and fully appreciate that the need for guidance and / or advice is now greater than ever.
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