Last year was quite a roller coaster for pension planners – mainly thanks to the government’s announcement of pension reforms. The imminent death of the annuity industry was foretold, financial planning businesses saw their share price soar while life insurers plummeted, and we all spent a considerable amount of time speculating as to what the longer term impact might be. With just a few months until the new rules come into force, let us look back at these and other major events of 2014.
The annuity is dead – long live the pension
The stock markets had no doubt as to the impact of the government’s programme of pension reforms. Within a few days of the announcement of the reforms in the chancellor’s Budget in March, life insurers such as Legal & General saw their share price fall by 12 per cent while IFAs such as Hargreaves Lansdown rose 15 per cent. With no requirement left to buy an annuity and restrictions or disincentives on drawdown and cash lump sums largely removed, a new world of retirement planning was quickly envisaged. Clients would be able to take larger lump sums and invest outside of the pension environment – using Isas, property and structured products – or take advantage of a much more flexible drawdown regime to take higher incomes than were previously allowed under the Gad limits. The net result? More need for personal financial planning, less demand for annuities.
The new landscape is equally attractive for high net-worth individuals as it is for those with more modest ambitions. Wealthier pensioners have more freedom to invest, allowing them new lifestyle choices. Lower income pensioners can take a significant lump sum instead of a pittance in annuity pension – offering them new lifestyle choices too. At the lower end of the spectrum the state could lose out if retirement pots are exhausted too quickly. But despite this obvious concern, the reforms have been met with widespread approval – so much so that it is difficult to envisage a government eyeing its popularity rating ahead of an election not following through with the proposals as promised.
Transfer window
Rumours were spreading among the defined benefit pension community last year of a higher volume than usual of transfer enquiries being made by members. It should not be a surprise that final salary scheme members want to benefit from the freedoms now available to other pensioners, but they can only get them by transferring out.
Transfers are normally good for DB schemes as the cash transfer value is less than the actuarial cost of the benefits. So trustees will be minded to grant them where possible – and that will lead to a bumper case load for IFAs specialising in pension transfer advice. Many noted an uptick in queries over the winter, although it will not be until after April that these translate into action. In order to facilitate this it was announced that the onerous qualification requirements to allow IFAs to advise on transfers would be relaxed; although this has not been clarified.
And what is not clear is whether a recommendation to transfer is always necessary for a client to proceed – or whether evidence that advice has been taken (whatever that advice concluded) is sufficient to satisfy the new rules governing this process. Many pension administrators currently refuse to accept transfers without an IFA recommendation. But the new rules do give transfer advisers more scope so that, taking all a client’s circumstances into account, positive recommendations are by no means out of the question. But either way, the new rules announced in 2014 were expected to keep IFAs busy for the next few years.
Inter-generational transfer
Another item on the reform bill that caused considerable head-turning was the proposal to scrap the current inheritance tax rules and allow pension pots to be inherited tax free instead of deducting a 55 per cent tax. This makes drawdown even more attractive and does further damage to the annuity market, although the chancellor did attempt to make a more level playing field by extending the rule to inherited annuities in his Autumn Statement.
How low can it go?
Just when you thought long-term interest rates couldn’t get any lower, 2014 saw yields on 15-year gilts fall near to the all-time lowest levels reached in August 2012 when they sunk to 2.02 per cent. Fortunately, equities had a strong year. Global equity income funds were up around 8 per cent year to date by the beginning of December. All this plays into the hands of the new pension reforms because low long-term rates make annuities more expensive, and rising equity markets make drawdown more compelling.
Why buy guaranteed income at one of the highest prices it has ever been when you can get variable income plus potential capital appreciation, allow your children to inherit anything left over and change your mind at any time by taking some equity risk? But the continued decline of the long-term interest rate during a period when almost all investment experts expected the rate to rise does beg an important question. Are long-term rates (ie, not Bank of England base rates) at a low point in the cycle of a normal economy – or at the mid-point of a long term decline of a failing economy?
Chart 1 compares long rates in the UK with those in Japan. Are we like Japan 10 years ago, where rates continued to slump to near 1 per cent? Or will UK rates revert to their long-term mean sometime soon as our economy, and inflation, picks up? Answers on a postcard please; the winner will be declared in 2030.
Squeeze the fees
With the RDR in full swing and the government on a mission to cap costs in auto-enrolment pensions, fees have been under pressure in 2014. Whether it is the adviser charge, pension admin cost or investment fund fee, planners have been looking for ways to keep clients’ overall costs under control. As has been noted in this column frequently, that is no bad thing, as saving 1 per cent a year on fees can significantly boost final retirement pots – by as much as 50 per cent. Understandably, advisers are keen to preserve their business model and profitability, but most clients can cut their costs significantly simply by switching to cheaper funds. As a number of research studies have shown in recent years, including one published by the Pan Asset team in October, switching from active to passive funds can give you that 1 per cent saving and boost performance (see ‘The Passive Fund Premium’, Charles Stanley Pan Asset).
A vintage year
Overall it has been quite a year for pensions – and an unexpected one on many fronts. It seems 2015 has much to live up to. But if it can make good on the promises made in 2014, rather than make any new ones, we should all be happy.
Bob Campion is head of institutional business at Charles Stanley Pan Asset Capital Management
