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John Greenwood: Pension reforms are positive but there will be casualties

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I am not sure what is the more breathtaking – the substance of what Chancellor George Osborne has done to pensions or the manner in which he has done it.

He has revolutionised the world of pensions, sweeping aside a 90-year consensus that pension saving has to be about providing an income. 

It was a bravura piece of politics that has put clear water between the Tories and Labour. Any politician wanting to oppose the policy is going to have to argue that the nanny state knows better than the individual when it comes to their money.

The policy scores on a number of key points. At a stroke it wipes away all the negative headlines surrounding annuities, it generates money for the Treasury, it will pump money into the economy and it will make individuals think about their retirement. And what is the argument for pensions liberation now?

It will also pour more fuel on the housing market as retirees use their cash to secure income through buy-to-let, which will be good for some but not for others. 

But for all the positives, it is disingenuous to argue people will not erode their pension savings years before they die. Behavioural finance experts have spent the last decade telling us human beings are hard-wired to spend today and take tomorrow as it comes.

The policy costings paper published alongside the Budget is silent on what will happen to the cost to the state of the extra Pension Credit likely to be payable to those who drain their funds. The single-tier pension does not abolish means-testing. This policy will increase it.

For some retirees, spending everything straight away and then going on state benefits will make financial sense. This moral hazard already exists for those with funds up to £18,000.

The debate is currently framed around profligacy versus self-control. But many retirees will end up withdrawing all they have to pay off debts.

Prudential’s Class of 2014 study found 17 per cent of those planning to retire this year have debts averaging £24,800. The interest they are paying on these debts is almost always going to be more than the post-tax return they could have expected in drawdown. In purely mathematical terms, clearing debt makes financial sense, even if it does mean these individuals will have less or no personal pension for the rest of their retirement. But an easy pot with which to clear credit card debts can also lead to people spending beyond their means.

Then there are the people who will draw their pension before they even retire. The pensions liberation saga shows us the lengths people will do to get their hands on cash today, even if they know it means considerably less cash in the future.

The Treasury predicts around 30 per cent of people in defined contribution schemes will draw down their pension at a faster rate than via an annuity. 

There is no doubt that this policy is a short-term vote-winner. It will revive interest in long-term saving, but there will be casualties.

If the intention was to explain to people they are responsible for their retirement, Osborne could not have picked a better way of doing it.

John Greenwood is editor of Corporate Adviser

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Comments

There are 13 comments at the moment, we would love to hear your opinion too.

  1. “It is disingenuous to argue people will not erode their pension savings years before they die.”

    Surely it is disingenuous to argue that people are arguing this?

    What I have heard is the government is saying that:
    – Yes, some people will fitter their pensions away.
    – But it is their right to do so.
    – If they do they will not be any more of a burden on the state than their more cautious retirees because of the triple lock.
    – These reforms will mean more money is saved into pensions. Behavioural finance says that people generally treat large sums of more carefully than small sums. So on balance it should be a net win for the country.

    Of these three point the last is the arguable one. But if my experience of the last few days is typical then people are already saving more via pensions as a result of these reforms. We’ll have to wait an see to see if people treat those larger pension savings as carefully as we hope they do. And that’s the point.

  2. As taxpayers, we already foot the bill for someone getting tax relief on their pension contributions.

    Now, we could be asked to pay again when someone blows their pension fund at age 55, 10 years before their state pension starts, and lives off means tested social security for nine years.

  3. goodness gracious 31st March 2014 at 4:08 pm

    Tim understands, Smithy and John Greenwood don’t. Evidence from the USA and Australia as well as Denmark do not show us that pots will be emptied ASAP.
    The feckless will have no access to state benefits once the flat rate state pension comes in so there will be no bailing out, but at least those feckless may have repaid debt and had a good party!
    What these changes will mean is that the overwhelming majority of employees will be less likely to opt out of AE and pensions will be refreshed in a way you could not have recognised a few years ago.
    Lets just hope the FCA thinks along these lines and do not re-set to the old way of thinking that a MP pension is for income only.

  4. Nick Pilkington 31st March 2014 at 4:21 pm

    Whilst George’s proposals appear attractive & certainly for the government they are, there are some serious drawbacks.
    Any cash sum paid out will be taxed at the individuals highest rate so a £100,000 pot could be reduced to £60,000 (however I would assume the pension providers will offer gradual encashment to keep tax down to 20%).
    Smaller pots that might not fall foul of higher tax rates could result in existing benefits being withdrawn.
    Also I cannot see any adviser suggesting this as a prudent route because, whatever the situation, I suspect the regulator, or certainly the FOS, would back any individual who had been advised to withdraw his money and then spent it & claimed he didn’t understand the consequences. Ridiculous I know but it appears that regulators assume individuals are idiots and cannot be held responsible for anything they do.

  5. If I were to give the Budget a title it would be “The Budget for Suckers’

    Osborne is being disingenuous. Not only is it a tax grab, but it is also has a major logical flaw. If you can treat people as being responsible – which they are not and never were – then why do we have this huge panoply of Regulation? If in effect Caveat Emptor will apply to frittering pension funds, why can’t it apply to all the other aspects of saving and investment?

    Either the great unwashed are responsible or they are not – you can’t have it both ways – unless of course you are a politician.

    And all this talk of saving is a chimera. The ONS has just reported that the savings ratio has fallen 5.1% in 2013 and continuing to decline, compared to 7.3% in 2012 and over 9% in Maggie’s day. This when many are already in compulsory AE – so the real (Non-compulsory rate) is likely to be significantly less.

  6. To John

    You stated in this article

    “It will also pour more fuel on the housing market as retirees use their cash to secure income through buy-to-let, which will be good for some but not for others”

    God I do hope that you’re not a financial adviser as I do believe that no self-respecting adviser would recommend a client in cash they are pension and pay tax on the income to invest in a buy to let property which is going to pay the following taxes:

    Stamp duty
    Income tax on spare rent
    Capital gains tax on disposal
    Inheritance tax.

    I haven’t even started on the inherent risks like damage to property or avoid rent or non-payment of rent.

    Compare that to a pension

    Tax relief on contributions
    Tax free growth even on interest-bearing assets
    25% of fund tax-free
    The ability to draw out what income you require from the remaining pot at marginal rates.

    Why would anybody invest in a buy to let property, they may use a property fund but why invest in a single asset other than commercial property.

    This could be good news for the property market if the government sticks to its ban on residential property within pensions as we could see the general public move away from buy to let investments. – which is good news for the youth of the country and provide a more stable housing market.

  7. Presumably the reason we existing pensioners, forced into an annuity, have had to forego the capital for our children to inherit, was that the capital is a necessary element of the income paid out to us. In other words, we gambled on our life expectancy to the total detriment of our spouse’s later income and our children’s inheritance. And if we lose the gamble, our money is given to others.
    If that’s the case, then presumably those who retain their capital will be unable to achieve the same (albeit dismal) level of income as us “lucky” annuity holders? But of course they will have the option of cashing in their buy to let or whatever and living off the capital in their latter years, if that’s what they choose. We don’t get that choice. My question is – why not?

  8. Harry, some of us unwashed are responsible & some aren’t. You not only can have it both ways, you don’t have the option, you’re stuck with it.
    So of the following:
    1. buy an annuity, get maybe 5%, gamble on when you die; lose it all at that moment (if any spouse guarantee has elapsed);
    2. buy an income-producing asset (residential might be an option), get maybe 5% net, gamble on capital growth (fair long term gamble?); sell it when you’re 85 or 90 & live off diminishing capital + whatever interest it produces; leave what’s left to kids;
    3. as 2 but keep it for your kids to inherit it all;
    4. Lambo & its derivatives,
    which is the most responsible?

    Peter, you are comparing apples & oranges:
    The 3 pension benefits you state are all benefits that accrue during the saving process & the buy to let pensioner will have achieved them.
    And there is the little matter of retaining their capital if they get a buy to let. What can they do with their pension pot capital, at any time during their life, if they have an annuity? I don’t expect an answer to that because there is not one (answer or pot).

  9. Richard L

    A buy to let property is an asset which happens to have a yield rate?

    Are you saying that managed funds is not an asset and doesn’t have any yield rate?

    So I’m not comparing apples and oranges I’m comparing the taxation of different asset classes!

    I repeat why would somebody take money out of a tax-free environment to invest in a taxable environment, particularly when those assets held under the tax-free environment can equal or surpass the growth of the taxable environment.

  10. @Richard L

    I wouldn’t wish to be a client of yours. Ever heard of joint life annuities? Where do you get 5% from? Most annuities I have seen provide 6% and upwards and considerably more for impaired and enhanced. I do hope you are not allowing your healthy clients to retire at 60.

    What is the sense of withdrawing money from a partially tax protected pension fund and reinvesting it into assets with no tax protection. (As Peter Herd has pointed out) I assume the amounts will be more that the ISA allowance (for both husband and wife).

    Property. 5% yield maybe – but what of voids, maintenance, acquisition costs (stamp duty, solicitors, surveyors etc). If you need any money you can’t just sell a living room and if you use all your pension money (after paying tax at your marginal rate) you have all your eggs in one not very appealing basket. On top of all that we are in a property bubble at present (in London) so you may well be facing a capital loss for some years to come.

    Your logic is very flawed. If you buy a property – even outside London you are not going to see much change out of £250k. That supposes then that you have paid 45% tax on taking it. That implies a residual fund (after PCLS) of £454,545 – so you have just made Boy George £204,545 richer – just what he wanted mugs like you to do.

    So even with your figures you have just swapped an annuity income of £22,727 p.a (pre tax) for a rental income of £12,500 gross (before expenses and tax) with the vague prospect of some capital growth – if achieved will then negate the income and will require a compound rate of return of 3% compound over 20 years to get you back to the £454,545.

    I certainly anticipate an eventual annuity. Like my clients my pension is not my only asset, but will form a core with other anticipated income. It’s what you call planning.

  11. Peter

    Sorry perhaps I didn’t explain what I meant very well:
    Stamp duty – (along with other purchase costs) – yes, an initial setting up cost.
    Tax on “spare rent”. Obviously the rental income is taxed. The income derived from an annuity is also taxed.
    CGT on disposal – yes, but rarely a major stumbling block to a long term investment. And I’d prefer to have some capital to pay the tax on than not.
    Inheritance tax – yes, maybe, but again, there’s something there to pay the tax on. Not with an annuity.

    The income drawdown tax advantage is purely one of choice & if one wants to limit one’s income simply to avoid tax then that’s a pretty limited benefit. (If you’re on typical state pension then it’s only around £3K pa).
    So the apples are the tax implications of choosing a buy to let from your pension pot instead of an annuity. The oranges are the beneficial tax implications of the saving to achieve that pot, from which the buy to let option will also benefit once the pot is put to use. We are talking here about the purchase of an investment after the pot has accumulated, not during the saving process.
    I can hardly see how any tax implications of a buy to let where my capital is retained would be worse than not having that capital at all. Your argument seems to hinge on anything to avoid paying tax. But I’d rather have something to pay tax on than have nothing, which is the case with an annuity.
    Please, I’d be delighted if someone told me I’d been misled & confirm that my estate does, actually, get my pension pot capital back (even if it were taxed) when I die. Sadly, I’m not holding my breath for that confirmation. But alternatively, please explain how it’s better for my estate to lose that capital, albeit taxed, when I die.

  12. Bottom line.
    George needs the prospect of loads of tax revenue to enable a 2015 give away budget.
    Well look I have just given you all loads of money says George.
    Election to follow in May, What a great job we’ve done !!!!
    Just call me an old sceptic.

  13. For those with ‘small pots’ I anticipate that using triviality etc would be very tempting…

    £20k cash or £100 per month for life…?

    BUT for those who see their pensions are providing income in retirement it’s a very different situation. I’ve recently revisited a case I’ve just completed (using annuities) and on discussing the Budget with the client, we’ve agreed the advice remains the same – in his words – the work we’ve concluded “has removed a massive weight of his shoulders”

    I’ve also just conducted my first ‘post Budget’ meeting with an ‘at retirement’ client and again, having previously discounted risk based annuities/drawdown, we’ve again decided to stick with a lifetime annuity for the assets under consideration as he wants a baseline income in retirement….

    Whilst I anticipate more will use the flexibility we now have (e.g. bridging between retirement and BSP age), these cases demonstrate that, for many, having a secure income in retirement takes away uncertainty.

    Whilst we can use wizzy planning to provide ‘better’ (?) options than an annuity, such solutions will typically introduce additional costs, additional administration and (typically) uncertainty at a time when many clients are simply looking for a relatively easy life, a known income, and peace of mind….

    Setting aside the annuity/pension vs non-pension’ argument, I agree with the point above that yes of course property clearly provides a good yield, but there are plenty of non-property investments which can offer a reasonable yield whilst also providing much greater flexibility – e.g. the ability of selling ‘some’ of the asset and also presenting estate planning opportunities.

    Whilst there will be many focussed solely on selling the merits of property, I suspect that those who are impartial and independent may well look at the drawbacks of such an assets feel that there are more appropriate and flexible solutions for the average investor – after all, there’s a reason why we don’t simply invest everyone in the highest yielding fund for our income seeking clients!

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