Next April’s pension flexibilities could be “detrimental” to retirement income, with people likely to outlive their savings, the Organisation for Economic Co-operation and Development stated in a new report.
The OECD’s 2014 Pensions Outlook, published today (8 December), noted that the at-retirement reforms will enable large lump sum withdrawals that might increase pensioners’ control over their accumulated funds, but could also be “detrimental to both retirement-income adequacy and incentives to work, due to individuals’ myopic behaviour and insufficient financial literacy”.
It read: “The overall outcome depends on how successful individuals are in assessing their needs over their remaining life expectancy. In any case, such withdrawals bear risk that retirees outlive their savings, especially those with low wealth.”
To mitigate the risk of savers spending all their money too soon, the report suggested that savers could be encouraged towards “deferred life” annuities; those bought at a later age in retirement and used to pay income later in life.
The report also found despite the lack of a legal requirement to take future changes in mortality into account, annuity providers do so more often than pension funds.
Annuity providers in thirteen of the sixteen countries examined used mortality improvement assumptions in practice, whereas pension funds in only eleven of the countries tended to do so.
Failure to account for future improvements in life expectancy can result in a shortfall of provisions of well over 10 per cent of the pension and annuity liabilities, the report said.
However, it noted the annuity market was also facing challenges on both the supply and demand side and called for strengthening the regulatory framework to help pension funds and annuity providers deal with the uncertainty around future improvements in mortality and life expectancy.
Elsewhere, the report noted that overall, the current economic environment is characterised by low returns, low interest rates and low growth in advanced economies which is compounding problems for pensions systems.
It said that such factors may lead to lower resources than expected to finance retirement - or simply lower retirement income altogether.
The report stated: “Low returns reduce the expected future value of contributions as assets accumulated will grow at a lower rate than expected. Low interest rates may reduce the amount of pension income that a given amount of accumulated assets may be able to deliver, especially in defined contribution pensions.
“Additionally, low economic growth may reduce the overall resources available to finance pension promises.”
For Jim Boyd, director of corporate affairs at Partnership, the OECD report sounded an alarm to the industry.
He said: “It is yet another warning from a highly reputable and significant organisation about the risks of the pension freedoms.
“The OECD [report] is significant because we are in a similar position to many other advanced economies and many of those major economies appear to be heading in a different direction.
“The real relevance in the UK is that this highlights the importance of the guidance guarantee - one of the key recommendations that comes from this is insufficient financial literacy.”
Mr Boyd added: “Given the value that the OECD place on annuitisation, it is critical the language of the government doesn’t demonise annuities - certainly at the onset the chancellor’s annuity statements were very negative.”
Tom McPhail, head of pensions research at Hargreaves Lansdown, added: “We know for a lot of people an annuity is still an important element of retirement income and whilst the pension reforms are welcome for most people, a blended approach will be the right way to go.”
Pensions expert Ros Altmann said: “The case for deferred annuities is stronger than regular annuities, but it depends on the cost of the deferred annuities which is something that these reports are ignoring.”
At a recent panel debate, experts warned that the radical retirement reforms will inevitably mean consumers are not adequately protected or informed, leading to “bad outcomes” in the short term.
ruth.gillbe@ft.com
