On gaining pension freedom

British pension savers have been granted the freedom to spend their pension pots how they choose. Amid the hype, does what’s happening tell us anything useful?

As described here the UK market is still unsettled following the unexpected end of the requirement for most people with money saved in a defined contribution (DC) pension to buy a lifetime annuity. Pension savers aged 55 or over can now take out all or part of their pot, subject to tax rules. Government agencies, including the Financial Conduct Authority (FCA) and HM Revenue & Customs publish statistics on what is happening and industry organisations have published their own surveys to try to understand actual behaviour.

However, this data might not imply lessons that could be applied elsewhere, because:

  • Actions taken now might not be a guide to future consumer behaviour. They could be a one-off reaction to the rule changes such as people taking advantage of being able to tidy up small pots by spending them. Or, actions may be constrained by the expectations of the recent past. For example, drawdown products are available but not all providers offer them because of the annuity requirement. It is hoped people are able to accumulate larger amounts in future, but the current situation is dominated by small pots. FCA data suggests 69 per cent of all pots accessed in the latest quarter were worth £30,000 or less.
  • Personal situations are so varied that it is not easy to see trends. The people who can take action cover a wide age range: 55 or older. They have different amounts and types of pension savings or other savings and may have pensions in payment. Motivations for action vary.  Statistics and surveys will not reflect the full picture, and different reports cover different parts of the market and count products differently. A report from the PLSA explains this well.
  • The UK rules are idiosyncratic. As explained here, EET means there are complex rules for how the tax due in the final “T” is collected. This gives rise to thick guidance manuals with such jargon-laden delights as the payment of an uncrystallised funds pension lump sum is a benefit crystallisation event for lifetime allowance purposes through BCE 6 if it is paid to a member who has not reached the age of 75*.

Adding to the difficulties in understanding what is going on, dramatic headlines are quite misleading. Over-55s spend pension savings on home improvements is just wrong.

At the risk of being proved wrong myself by later statistics or a misinterpretation of the UK’s unique situation, here are some conclusions from these reports. So far as it is possible to tell:

  • People seem to be fairly sensible about how they draw down their pension. People were more likely to use advice the bigger their pot size. The most common withdrawal rate on partial drawdown was less than 2 per cent of the pot in a quarter (FCA).
  • The annuity market share looks like being at the lower end of previous estimates. The FCA has annuities taking 13 per cent of pension pots that were accessed and PLSA says 32 per cent of those who took action to use their whole pot bought an annuity. Differences in product definition and survey coverage explain some of the difference. As discussed here, experience from various markets suggests that perhaps 20 to 40 per cent of older people might find annuities attractive.
  • Risk that annuity buyers make mistakes. The FCA data shows that annuity purchasers are mostly aged 65-69, and have pots worth less than £30,000. Compared to those who accessed drawdown, they are more likely to stay with their current pension provider and less likely to access financial advice. Most annuities bought are not indexed to inflation, will stop on the death of the purchaser without cover provided for a partner, and the level of income is not enhanced by an underwritten medical impairment. These features means an annuity yields around £150 a month, less than a quarter of the new state pension, from a pot of £30,000**. Is this in the best interests of the buyer?

Pension freedom was expected to shrink the annuity market as more product choices become available. This is happening. But it is not yet proven that people are actively choosing the right annuity for their needs. Annuities continue to be bought with features which are the opposite of what the Money Advice Service – the government provider of free and impartial money advice – urges people to buy. Pension freedom still leaves the risk that some annuity purchasers make mistakes.

What’s needed is less hype about how some people might be spending their money, and more noise about how people can get some useful help.

 

* This rule is a consequence of being able to take pension money from a pot at a relatively young age (55) while you still might be contributing.

** From the Money Advice Service annuity calculator February 2016 for a healthy 67 year old female living in rural England.

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