Editor’s comment: Are pension freedoms really making retirees better off?

Three years on from the introduction of pension freedoms, it seems that fears of retirees withdrawing their entire pension pots and blowing them on Lamborghinis were very much misplaced. Indeed, a much more pressing risk appears that they are being too fearful rather than too flash with their cash. Pension freedoms were introduced in April 2015 to give people the option of drawing an income directly from their pension fund or even cashing it in altogether, rather than simply having to buy an annuity that would provide a secure lifetime income, as most people were required to do before that time. 

Pension freedoms have proved popular

At a single stroke the pension freedoms caused a revolution in the way people access their retirement pots. The freedoms have proved immensely popular: according to the latest government statistics, more than £15 billion has been paid out in flexible payments since April 2015. Drawdown has rocketed. Cash withdrawals are commonplace. Annuity sales have slumped. 

But what’s the overarching aim of the pension freedoms initiative? It’s been great, certainly, for informed investors who read Money Observer and enjoy the challenge of managing their own pension pots, and for those with the wherewithal to pay a financial adviser to run their portfolio, for such investors are free to invest their way to a more prosperous retirement.

However, simply giving everyone freedom to access their money in a different way can’t be viewed as a success unless the large majority are better off in retirement as a result. So far, the evidence suggests that that’s not necessarily happening. Once again it comes back to the basic fact that, despite the greater choice available to them, so many people still don’t understand or engage with their pensions, nor do they want to pay for advice. 

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A recent review by the Financial Conduct Authority (FCA) found that 37 per cent of those opting for drawdown did so without taking advice; typically, they simply took the drawdown plan offered by their provider, rather than shopping around. Alarmingly, according to the FCA, many were ‘not even aware what product they had, what the charges were or what they were invested in’, and there was a clear risk they could have bought an investment that was too highoctane (or low-octane) or didn’t suit their circumstances. 

The trouble is that drawdown is a complicated beast that must be carefully corralled to ensure the fund lasts a lifetime. And that ideally means taking professional advice, at least at the outset. To illustrate the complexities involved, in its new report on pension freedoms the Work & Pension Committee (WPC) tested the impact of withdrawing too large an amount each year on the length of time a pension fund would last, modelling the difference if someone with a £50,000 pot opted to take out £3,000 rather than £2,000 a year. It found that on £3,000 they would run out of money within 16 years (well below average life expectancy at age 65), receiving total income of £52,200. If they withdrew only £2,000 a year the fund would last 29 years, producing total income of £67,500. 

The FCA also looked at those who cashed in their pensions. It concluded that the danger is not of reckless spending on fast cars, but of ‘misguided conservatism’. According to the FCA a third of people making full withdrawals played safe, putting most of their pension cash in savings accounts in case they might need it in years to come; there, of course, it has precious little chance of even keeping up with inflation, let alone growing in value. 

As things stand, therefore, there is a real danger that many people who have followed the drawdown option may find their income strategy doesn’t meet their needs or means they run out of money down the line. Meanwhile, those who have taken cash live a less comfortable retirement than they need to, because they are too nervous – of markets, of the pension system, of the future – to make their money work for them. 

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So what’s to be done? The WPC makes several recommendations, in two main directions. First, it points to the success of auto-enrolment in using default pension contributions to harness inertia and get employees saving en masse in recent years, and suggests something similar for accessing pensions – a pathway to ‘suitable’ lowcost, properly overseen default drawdown options, on which people will end up if they don’t make active choices themselves. However, there’s a big question over how a ‘one size fits all’ solution could work in practice, given the diversity of people’s situations. For instance, some still have final salary pensions running alongside these pension pots, but others have no supplementary income sources; would a default pathway pick that up or take account of it? 

Secondly, the WPC makes suggestions as to how to get people more engaged with their pension and at an earlier stage, through various initiatives including default guidance and professional advice. More engaged consumers would also mean more people shopping around, and therefore more demand for competitively priced, easy-to-understand drawdown products, which have so far been surprisingly lacking in the post-freedoms pension market.

In the end, though, generating widespread public interest in achieving a more comfortable retirement is bound to be a long-term project; in the meantime, there’s a big question mark over whether a default drawdown arrangement will protect those in danger of making no pension decision at all. 

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