This year’s Budget will go down in history not only as a pivotal moment for the pensions industry, but more importantly for the long term savings behaviour of Britons.
Chancellor George Osborne’s revolutionary Budget – which he has described as the biggest overhaul of pensions since 1921 – cannot be accused of lacking boldness. At a stroke it has changed the public perception of pensions from a dingy wrapper that funnels you towards a miserable annuity to an open, transparent and potentially lucrative tax management scheme that outranks Isas in a number of ways. For a product that has been battered by bad press for decades, that has to be positive news for pensions.
But soon after the initial euphoria had started to wear off fears started to emerge that the Chancellor may have gone too far too quickly. Will the public be able to resist spending all they have within a few years of retirement, leaving them on state pension for a retirement the length of which they have probably underestimated?
Aon Hewitt senior partner Kevin Wesbroom says: “Real surprises in Budgets are rare but today’s announcements mean a whole new ball-game for DC pensions. This is clearly welcome news for members as they will get greater flexibility to manage their finances – however it may have unexpected consequences.
“Flexibility comes with risks and responsibilities – members may outlive their funds and become dependent on the £7,500 a year state pension.”
Given the speed with which the system will change, DC schemes are going to have to change very quickly, with investment strategy a key and pressing issue.
Barclays Corporate & Employer Solutions investment consultant Lydia Fearn points out: “The majority of default strategies employed by auto enrolment schemes switch into long dated bonds and cash to more closely match annuity rates and, in light of this announcement, many of these will need to be reviewed to take account of the way in which people will likely take their retirement benefits in the future. A number of our clients have already introduced non annuity target strategies to provide flexibility for employees.”
DC investment advisers and default providers are therefore going to have to calculate pretty quickly the proportion of scheme members they now expect to annuitise and overhaul their investment strategy accordingly, with a new view of what an investment target should be.
Association of Consulting Actuaries chairman Andrew Vaughan says: “Clearly, we need to examine the Budget papers in some detail, but it will be important that DC members already in lifestyle strategies who are on a path towards annuity purchase don’t get stuck in inappropriate assets.”
The requirement for DC providers and trustees to offer at-retirement guidance by 2015 will also be problematic. Who will pay for it? Will it push up charges or drive away yet more providers from the market? And what will the guidance look like?
Sanlam UK head of investment solutions Rick Eling points out that the £20m the government is setting aside, over two years, to help with the cost of this advice works out at £22.50 per retiree.
Eling says: “Industry figures show that 450,000 people either entered drawdown or bought an annuity in 2012. That means only £22.50 per person to fund the planned advice on retirement. And some of today’s changes to pension and Isa rules might make it even harder to work out the best way to go.”
However, the changes will make pension much more attractive when held up for comparison against Isa, as it has been so many times in the past.
As if the industry didn’t have enough on its plate, it now has until April 2015 to consult on these issues and formulate and implement new rules.
The Treasury is also consulting on the extent to which the changes to the world of DC should extend to defined benefit pension schemes.
Broadstone actuarial director John Broome Saunders argues DB scheme sponsors should be fighting hard to benefit from these changes. He says: “If DB schemes can benefit from these changes, they will be able to offer more flexible options that pay out more cash, sooner, to pensioners. That has enormous benefits for scheme sponsors, especially those with crippling legacy pension liabilities, as it allows these liabilities to be settled sooner, and reduces – possibly significantly – the longer-term mortality and investment risks attached to pure pension provision.
Then there are the short-term moves – will we see a flood of CETVs before the gates are locked? And what of the Isa-like flexibility of pensions. To what extent will we see people max-ing out on their contributions and then drawing benefits very soon after? Recycling rules are likely to be beefed up accordingly.
Osborne has delivered a Budget that creates a new paradigm for pensions and retirement saving. The ‘makers, doers and savers’ at which it is aimed will welcome it with open arms. Whether it leaves the less disciplined members of society ultimately worse off remains to be seen.
