Pension FreedomFeb 8 2022

Pension freedoms: were they really a good idea?

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Pension freedoms: were they really a good idea?
Credit: Fotoeye75

While this new found freedom felt glorious in the early days, savers found this liberation came with difficult decisions, which many people were not equipped to make and help from government and regulators was simply not up to scratch.

When these radical pension freedoms were first unveiled by then-chancellor George Osborne in Budget 2014, it came as a shock to the industry who were otherwise expecting a quiet day.

The pension freedoms legislation, which came into force from April 2015, allowed savers to flexibly access their defined contribution pension from the age of 55 and use the funds for a wider range of options, including cash withdrawal, retirement income products or a combination of the two.

Before, savers looking to retire only had the option to buy an annuity, sold by insurers which turn funds into a regular guaranteed income. However, these were becoming poor in value as rates began falling.

The consequences of freedoms have been felt in recent years with unsophisticated savers putting money into high-risk investments, defined benefit transfers becoming more popular and scammers using all sorts of tactics such as cold-calling and disguising themselves as investment companies to get people to hand over their money.

Scams have certainly been one of the largest impacts of the reforms and data showed that more than £30mn had been lost to pension scammers between 2017 and August 2020.

So this is why we now find ourselves asking the question: are pension freedoms a success or a regret?

Hopelessly dipping in

Since rules were relaxed on how pots can be accessed savers have made good use, with retirees collectively withdrawing huge sums each year. Latest data from HM Revenue & Customs (published in April) showed more than £45bn has been taken from pots since 2015.

The concern is that this money has been taken out irresponsibly, without proper guidance or advice or concern for the consequences, something that pension freedoms made possible.

Steve Webb, who was pensions minister at the time these freedoms were introduced, says that while some people may be withdrawing at unsustainable rates, there are others where cashing in a pot made sense.

“There are a lot of people who have got multiple pension pots, and to take one of these pots at age 60 to tide you over till you can get a state pension at 66 and literally take a sixth of the pot a year for six years may be entirely sensible,” Webb explains.

Recent data from the FCA showed the most popular withdrawal rate was 8 per cent or more, with the exception of pots worth more than £250,000.

In the 2020-21 financial year alone, more than 217,000 people with pots worth less than £10,000 decided to fully withdraw their pension. This compared to only 13,000 who decided to use partial drawdown so that some of their fund remained invested.

Meanwhile, larger pot sizes of £250,000 or more saw nearly 27,000 choosing partial drawdown compared with only 357 who fully withdrew their pot.

So after six years of flexibility, does this mean that people are understanding when it is a good idea to cash in the whole pot?

It appears that for some, keeping their pot invested will be in their best interest rather than withdrawing it all and keeping it in cash where it will not make any returns.

As the FCA data showed, those with larger pots are more likely to enter drawdown and keep some of their money invested, to ensure that the pot lasts them for the rest of their lives

Claire Trott, divisional director – retirement and holistic planning at St James’s Place, says people have definitely been made to stop and think before they just take all of their money out.

“I think that would have been the biggest risk to people, just accessing everything and paying way too much income tax, rather than probably many other risks you could think of. [People tend to] want it somewhere where they understand it rather than it being in a pension that they don't understand.”

Timing issues

The industry has often said that these reforms were rushed through too quickly, and if more time was given any potential issues could have been ironed out before they became an issue.

Generally speaking, rumours swirl for months in advance of the Budget about what it will contain; freedoms seemingly came out of the blue.

In fact Trott can remember the shocking announcement, as expecting it to be fairly quiet, she had stepped away from her desk when the pensions world was turned upside down.

“I think they probably didn't consider the knock-on effects on what the announcements would do to the industry and what people would do when they were told they don't have to lock in [to an annuity],” she says.

But Trott is not sure that delaying it or phasing it in a different way would have made much difference.

Others would have liked the industry itself, as well as the regulators, to be more involved.

Martin Tilley, head of technical and director of WestBridge SSAS, says had the proposals been launched in a consultative form, many of the complications that have emerged over the past six years would have been identified by the industry. This way the government would have felt compelled to address them in advance rather than after the reforms were pushed through.

“[Pension freedoms] were rushed out too quickly, [with] insufficient time for PensionWise and other bodies to gear up and be effective,” Tilley says.

Giving more warning could have also had adverse effects, and could have see a torrent of money all on one day, Webb argues.

“There is an optimum here,” he says. “You don't want to do it overnight, but what's the right length of time? Yes, more notice could have been given, but there's an awful lot of hindsight.”

Cry for advice and guidance

One of the main reasons more timing was needed was so that guidance providers and advisers could prepare and the government could promote the benefits of getting help before people dove into their pots.

This is something the Work and Pensions Committee has looked into recently in its report on pension freedoms, where it recommended a number of areas where savers need more support with their pensions.

For example, since freedoms were introduced, it has been a long-running issue that the take up of guidance from Pension Wise is too low and that programmes to boost advice, such as the pensions allowance, are not working.

The report has therefore suggested automatic Pension Wise appointments should be trialled and that the advice allowance needs an overhaul.

The advice allowance, which came into being in April 2017, allows pension scheme members to withdraw £500 a year tax-free, up to three times in their life, to pay for financial advice.

However, uptake has been low with few providers offering this service to clients.

Ricky Chan, director and chartered financial planner at IFS Wealth & Pensions, says reviewing the advice allowance makes sense as “it’s clearly not being used by the majority of consumers and there are limitations of its use depending on the provider”.

He adds: “Hence if this were made easier, then we should see an uptick in usage for financial advice/guidance.”

Rachael Hall, founder of advice business Seven Stages, says more needs to be done to educate people on pensions jargon.

“We believe the key to improving better outcomes is to also improve financial literacy, so allowances could be extended to employers, encouraging them to make educational workshops available for members, which enhance financial wellbeing.”

Or is it down to savers themselves to go out and get advice? 

Both the government and the FCA are introducing rules to “nudge” individuals to obtain guidance before accessing their pensions, but Tilley says these will not go far enough.

“Good quality advisers have existed and even free guidance has been available since the freedoms have been introduced,” he says. “In this instance availability of information on the internet, through guidance sites, through provider’s websites and multiple other outlets has meant that there are more than sufficient opportunities for the average individual to be aware of the tools that are available should those individuals wish to avail themselves of them.”

So, back to the question: are freedoms a total regret?

“I am not sure that the principle of the freedoms themselves should ever be regretted, since for the vast majority of individuals the additional flexibility they conveyed should only have been positive,” says Tilley.

“It is the individual pension-holders themselves who need to be reminded that they should not make decisions without knowledge as it is they who will regret them.”

As the well-known line from Spiderman goes: “With great power comes great responsibility.” Something pension savers have had to learn the hard way when it comes to pension freedoms.

Amy Austin is news editor of FTAdviser

What do you think about the issues raised by this story? Email us on FTAletters@ft.com to let us know