A peek into the future after freedom day
There are a variety of quotations that spring to mind when you consider the recent changes to the pensions market, but one of my favourites is from Kurt Lewin: “If you want to truly understand something, try to change it.” When the Chancellor announced his proposals in March 2014, I doubt anyone quite realised the size of the genie that had been let out of the bottle.
Now, as we start the final countdown to pension freedom day, the work and pensions select committee has released a report into automatic enrolment and the new freedoms surrounding pensions, which looks to set the agenda for the next few years. So, let us take a tour through the 19 recommendations and conclusions to see what the future holds.
Firstly, the report recommended the government establishes an independent pension commission at an early date after the general election,which would be tasked with reviewing aspects of AE, pension freedoms, pensions legislation and future pension policy. It went on to say that “if the new government does not accept that a pension commission is required, it will need to tackle the range of issues raised in the report”,which suggests this cross-party group saw some of these problems as having serious consequences.
Starting with AE, it heralded this scheme as a success due to low opt-out rates, but felt it needed to be tracked to determine its future success. It also suggested that minimum contribution rates are reviewed upwards. Currently, the AE annual earnings threshold excludes a large number of low-paid workers and – in the interests of ensuring people are supported to make adequate provision for their retirement – a review of this was recommended.
Small employers have been highlighted as potentially struggling with the challenges associated with AE and the committee recommended that the next government take the lead in ensuring support continues to be co-ordinated across regulators and providers. The issue of ‘pot follows member’ was also tackled and, while it was labelled as the “right solution”, it suggested the plans need to be outlined prior to October 2016 and the department of work and pensions needs to convince the industry of its merits.
Moving on to charges, the committee welcomed the progress the industry has made, but said that charges for legacy schemes need to be addressed and suggested working with the sector to develop effective solutions to increase the transparency of all pension charges. The costs around decumulation and drawdown were also highlighted for review.
The report then focused on the changes due to come into force on 6 April and acknowledged that “the full range of decumulation options envisaged by the government” are unlikely to be in place. It also highlighted that some options – such as cashpoint drawdown – are likely to be impractical even in the longer term and that certain schemes will not be in a position to offer the new options. This could mean consumers would need to move their pension to benefit from the flexibilities.
While the practicality of all the options is a topic that many within the financial services industry have been discussing – some as early as April 2014 – it is interesting to see that the DWP select committee has fully acknowledged this. It also argued the case for the importance of regulated independent financial advice as people are going to need help exploring the options they have.
The committee went on to say that “annuities are still likely to be the best option for many individuals”, but they will need to become more flexible, “for example, by offering fixed term rather than lifetime products, or combinations of annuity, lump sum and drawdown products”. It highlighted that prior to the changes the “annuity market had not been operating in the interests of savers”, but acknowledged that the freedoms mean “savers risk making poor decisions or being exposed to potential fraud and scams”. The committee recommended that the impact of reforms is fully reviewed and any necessary interventions are highlighted if the market is not operating in the best interests of consumers.
Pension Wise has been seen as part of the safeguards under the new system, but the report suggested it “will not be sufficient in itself” because level of take-up is not known and there is also some uncertainty about whether it will be fully operational from April 2015. It also suggested Pension Wise is transferred from the Treasury to DWP in due course.
To complement this, the second line of defence has been proposed. Looking to the future, the report made recommendations around changing the regulatory framework for pensions. It also recommended that the next government considers the merits of establishing a single regulator covering the whole remit of pension saving.
While few people in the pensions industry are likely to welcome additional regulation (since there does seem to be quite a lot of it already), working to create one cohesive system that works easily and well does seem like a step in the right direction. However, this may well be releasing another genie from a bottle.
The committee made repeated references to the importance of ensuring consumers are actively engaged in the process and therefore are supportive of the idea of the pension’s dashboard – recommending the development of it as a priority. The importance of developing robust financial literacy systems was also highlighted.
Pension schemes will need to adapt investment strategies to take into account the new flexibilities and the committee suggested that if meaningful evidence does not emerge that consumers are engaging with the process then default decumulation options may need to be developed.
With people able to access their pension from age 55, the committee is concerned that this may set unviable expectations of retirement age, so recommended that retirement age rises to five years before state pension age (except on ill-health grounds). This has garnered much of the press coverage of the report, but it does seem logical when the pension regime is viewed in its entirety.
Finally, while the regulation has changed to allow the use of shared risk and collective benefit schemes, there appears to be little appetite for them and the report recommended that the DWP does not divert resources to look at this issue until AE has been rolled out.
So, as we work to deal with the implications of the introduction of the new pension reforms, we need to be aware that, if these recommendations are picked up, we are likely to have a busy and challenging, but interesting, next few years.
Mark Stopard is head of product development of Partnership
Key Points
The work and pensions select committee has released a report into automatic enrolment and the new pension freedoms
The committee said annuities are still likely to be the best option for many individuals, but they will need to become more flexible
Pension Wise will not be sufficient in itself because level of take-up is uncertain
