Pensions: 5 years after freedom

In his Budget speech of 2014 the (then) Chancellor of the Exchequer, George Osborne, made this key statement;

“Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want.

No caps. No drawdown limits.”

Let me be clear. No one will have to buy an annuity.”

This change (which came fully into force in April 2015) become known as “Pension Freedoms”.  So - with the benefit of 5 years of freedoms experience - how has that change impacted the UK retirement savings landscape?

The positives

Before proceeding further it is important that we acknowledge the benefits of the 2014 Budget decision. 

Prior to the above announcement there was a growing public and media dissatisfaction regarding the pension outcomes being achieved for those who had saved for their retirement via Defined Contribution (DC) plans.

The key issue in this debate was that – for the vast majority of savers – there was little practical choice as to how most of their funds could be utilised when retirement was eventually reached.  The default option for most savers was the purchase of an annuity to provide a regular pension income throughout retirement, and the income being generated from such annuities was looking increasingly meagre to the untrained eye. 

So Osborne’s statement directly addressed this issue, and as a result both new and existing savers are now perhaps more encouraged to save for their retirement and take advantage of the valuable tax-reliefs inherent in pension savings.

Not all good news?

Yet there remain valid concerns that the freedoms might also encourage savers to utilise their funds in ways other than providing a regular income that will last throughout the entirety of the individual’s retirement years.

It is this important issue that a recent report looks into in some detail.  The New Choices, Big Decisions report takes an in-depth look at the decisions a group of savers made – and the actions they have subsequently taken – in accessing their retirement funds.  Amongst other things the research found that:

“our pension pioneers will need to navigate a plethora of risks, a journey which our research suggests they are ill-equipped for.”

Indeed the report consistently found that those taking their benefits suffered from “present bias”, effectively meaning that people only plan for the short-term and rarely look beyond a window of the next 5 to 10 years.  As the following paragraph (taken directly from the report) states:

“Pension freedoms have reframed pensions from being an “income for life” to “money for retirement”.  Members now fundamentally see their DC pots as just another form of savings.  This reframing from an “income for life” to “money in retirement” is a subtle one, but appears to be having significant behavioural consequences.  Present bias and the “ostrich effect” mean that members’ withdrawal plans typically ran for a maximum of 20 – 25 years and that few expected their money to last longer than 10 years.”

And that is – or at least should be – a key concern and problem for those in retirement, the pensions industry, and indeed the UK government too.  For if private retirement saving are indeed extinguished in the first 10 years of retirement, what (aside from any state pension entitlement) will be available to support the individual in their later retirement years?

The big risk

It’s a risk that just not enough people recognise or even fully understand. 

My personal experience of this particular issue suggests that people approaching pension age consistently underestimate the potential length of their retirement years.  Often their assumptions are based on nothing more scientific than the age their parents passed away, or the unexpectedly early death of a friend or recently retired colleague. 

Yet the (admittedly pre-COVID) life expectancy evidence suggests otherwise.  To borrow again from the report;

“The latest mortality statistics suggest that if you are 65 today you are just as likely to die in the next 10 years (14%) as live to celebrate your 95th birthday (18%), whereas in the 1970s the probability of dying in the first 10 years was roughly 14 times greater that the probability of living to age 95.”

Indeed this marked change in retirement life expectancy was one of the key reasons why the old annuity option (which usually offered an income that continued until death) became less attractive to retirees.  Faced with a rapidly lengthening payment term, providers had little choice but to reduce the annual annuity payments being offered to new policyholders to help balance their own risk and return.

Of course longevity of pension payments is only one area for retirees to consider.  How will their money be invested until it is needed, how safe is that investment, what returns will it achieve, how can money be disinvested tax-efficiently, how will future inflationary pressure impact income, and how can pension money be kept safe from pension scammers are all topics that those in retirement without a regular annuity payment should be thinking about too.  But the research also suggested that few of these “pension pioneers” were actively doing so.

What can employers do to help here?

All of which suggests that employees need all the assistance they can to understand the dynamics of saving for retirement during their working life, and to better understand the decisions they face once funds are accessed in their retirement years too.

This help can be supplied in a number of formats.  Signposting to pension provider websites is a great first step, and such pages usually provide a range of useful planning and reporting tools which should help employees understand their pension scheme and savings better.

And savers aged 50 or above can access free guidance around their retirement income options from the government’s Pension Wise service also.

Yet many good employers can and do go further in assisting their workers. 

A key issue here is to address any saving and planning issues early, when small corrective actions can still make a significant difference to retirement outcomes.  And the first stage in that journey is to explain to many more workers how much they need to save, what returns they need to achieve, and what investment risks might be suitable to achieve an adequate pension income for the entirety of their retirement years.

As we addressed in this post, regular pension surgeries (be they on site or delivered remotely via video conferencing tools) are an important and cost-effective step towards providing this support to workers of all ages.  And smaller employers in particular should also perhaps start to more actively engage in Pension Scheme Governance to ensure the best outcomes for all members.  For more information on our pension scheme services for employers please visit this page of our website.

So Pension Freedoms are very welcome, but also raise a new and more urgent need for understanding and education about retirement savings and pension income options.  It follows that employers should do all they can to help their workers in this increasingly important area.

For more information on any of the above topics, please speak to your usual Howden Consultant in the first instance, or visit our website for other contact options. For the latest details on COVID-19 & Employee Benefits provision please visit our coronavirus hub.

(Published 18/01/21)

Steve Herbert

Steve is Head of Benefits Strategy, Howden Employee Benefits & Wellbeing, and is an award-winning thought leader on Pensions, Employee Benefits, and Human Resources issues. He is occasionally accused of making Employee Benefits interesting.

Steve Herbert

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