Recent research has found retired people generally under-spend their financial assets rather than using them up as they age. This was quickly seized upon as justification for pension freedom. But are we not jumping the gun a bit?
The report from the Institute for Fiscal Studies looked at retired people over a 12-year period to 2014-15. It found the majority of financial wealth they held was not used to fund consumption in retirement and therefore was likely to be passed on as inheritance. In effect, people tended to draw on their liquid financial wealth quite conservatively.
That sounds like good news. So why should we be cautious about what it says on pension freedom?
The most obvious reason is that the period examined pre-dates the pension reforms of 2015. The figures tell us what people did when retirement choices were focused on delivering guaranteed income for life. We cannot be sure that will continue given tomorrow’s retirees face a dramatically different world.
The report highlighted an interesting point that those with higher levels of financial wealth (this does not include property or pensions) drew down that wealth more quickly than average, while those with higher levels of income drew it down more slowly.
That seems to suggest extra income acts as an insulator or insurance policy against having to tap into savings and investments. If the past does prove to be a guide to the future, those choosing to access ad hoc lump sums rather than divert them towards generating higher incomes could end up with less financial wealth to pass on to the next generation.
The IFS itself recognised these are very early days and suggested now individuals have more options on how to spend accumulated resources it will be vital their situation is monitored carefully to ensure they are coping with such responsibility.
Not without problems
Rather than looking to our own past, a better guide might be to consider the experience in Australia, where the over-55s have had flexibility to access pension cash for many years. Such freedom has not been without problems, prompting proposals on compelling trustees to put formal retirement income strategies in place for members.
Their experience is that some do take the cash too quickly: around a quarter empty their pots before age 70. But even the ones exercising prudence do not necessarily fare much better. Australia has among the world’s longest life expectancies and even those taking the minimum amounts to continue qualifying for tax exemptions still risk depleting their fund over a lifetime.
With optimising withdrawal strategies a matter of luck as much as judgement, the Australian government is set to insist on trustees offering at least one “flagship” Comprehensive Income Product for Retirement. This is designed to provide an efficient, broadly constant income, longevity risk management and some access to capital. The “flagship” denotes a plan trustees can champion as having features suitable for most members or a particular cohort.
Just as important will be the requirement on trustees to provide pathways – such as guidance, advice and tools – to help their members understand and make choices about the retirement income products on offer.
Members will still have the freedom to select another product or take personal financial advice and trustees will not have to offer it if they know it is not suitable – for example, for someone with a life-threatening or terminal illness.
Issues still abound
Just compare the activity in Australia to our fingers-crossed approach in the UK, where we do not even capture the right data to properly understand what is developing.
None of the issues we faced under our old pension rules, such as lack of engagement and shopping around, have been solved by freedom and choice. Even relatively modest steps, such as calls for auto-enrolment into pensions guidance unless people actively opt out, were not approved by the government, instead passed over to the FCA to resolve.
Australia is clearly taking major steps to get on top of its problems before they spiral out of control. Can we say the same over here?
Stephen Lowe is group communications director at Just Group