Chris Gilchrist: Pension rules mean dangerous decisions could be made

Few people have yet realised that the new pension rules create a nightmare for individuals, forcing them to confront and make decisions they are ill-equipped to make and would rather avoid. The consequence is that through inertia or fear, many people will not make the decisions they need to, while many more will make decisions that turn out to be wrong for unpredictable reasons.

The cause of this slow train crash is the abolition of forced annuitisation. We know that when the concept of the annuity is put to people, they do not like it. Take-up of annuities, when they are a purely voluntary investment choice (as in the US), is minimal. We also know, thanks to the learned professors, that for many people, the annuity is (at least in theory) the best choice for a pension pot because of longevity and the uncertainty of investment returns.

So, for many people, advisers ought to recommend annuities and, if they properly take account of risk capacity, should probably recommend them more forcefully than they do. Nevertheless, if people hate annuities and do not want to buy them, you cannot criticise advisers for offering them alternatives. But given the real possibilities of fixed annuitants being bankrupted by inflation and of draw-downers being ruined by a crash, advisers have to present what many of their clients will see as a devil-or-deep-blue-sea proposition.

Even bigger problems come with the management of pension funds over the period up to a retirement whose timing is less and less likely to be at all definite.If you know you are going to buy an annuity at age 65, you should, over the preceding decade, convert your fund from equities to cash. But if you were planning to enter drawdown, there would be no need to do so. On the contrary, you would aim to manage the portfolio so that by the time drawdown started, it had the appropriate allocation for drawdown, so you would probably maintain a high equity content.

The trouble is that many people in their 50s do not know when they will want to start drawing from their pension fund, let alone in what form (annuity or drawdown) they will want to do so. However good the advice they get on this issue, the result is sure to be that a significant minority, even of those who seek advice, will take what turn out to be less than optimal decisions. Those who take decisions based on intended drawdown who later have to revise that decision due to changed circumstances may incur substantial detriment relative to the lower-risk alternative they had earlier decided against.

The risk of advisers being blamed for such poor out-comes is obviously high, yet if fear of claims against them on these issues causes advisers always to recommend lower-risk investment strategies based on annuity purchase, another set of people will certainly lose out as a result of obtaining lower returns.

Quite how this will work out in practice is hard to predict. But it is clear that many people will find it hard to make the best or even good decisions. It also presents advisers with a really tough challenge in guiding clients through decisions they enjoy as much as they would being impaled on a red-hot fork.

Chris Gilchrist is director of Churchill Investments and editor of The IRS Report