View the article online at http://citywire.co.uk/money/article/a886274
Pensions risk 'unravelling' due to freedom reforms
Without compulsion to buy an annuity the pension system is in danger of falling into a black hole, according to a report for Labour.
Last year's pension freedom reforms risk ‘unravelling’ the pension system as retirees are no longer forced to secure a retirement income, a review for the Labour party has warned.
The Independent Review of Retirement Income, commissioned by Labour two years ago, argues that scrapping the requirement to buy an annuity with a pension pension pot at retirement has removed the reason for saving into a pension in the first place.
Pensions are precious
David Blake (pictured below), chairman of the review and director at the Pensions Institute at Cass Business School, said a ‘national narrative’ around what a good retirement looks like needed to be established.
‘Without this, people’s aversion to annuitisation combined with their willingness to pay highly for flexibility and guarantees could leave them worse off than if they purchased an annuity to begin with,’ he said.
‘This is a significant challenge. But it is one that is well worth the effort because, as the pensions minister Ros Altmann says: "pensions are precious".’
The report, states the primary purpose of a pension scheme ‘is to provide an income in retirement for however long the scheme member lives – that is, it will not run out of money before the member dies’.
To that end the ‘unifying thread’ that used to run through pensions was ‘the requirement to annuitise enough pension wealth, at the appropriate age, to provide an adequate lifelong income in retirement when combined with the state pension – which is the rationale for establishing a private-sector pension scheme in the first place’.
Honey pot for thieves
However, the report goes on to say that when annuities become optional ‘That unifying thread is no longer present and there is a real danger that the pension system begins to unravel’.
‘At best, it becomes a tax-favoured agreement for operating a multi-purpose spending pot – once the money has been spent for one purpose, it cannot be spent on another,’ said Blake in the report.
He added that at worst it becomes a ‘honey pot for thieves and other opportunists’.
Adding to the problems pensions face is the lack of understanding around how to generate a retirement income.
The report noted that private sector employees are being auto-enrolled into pension schemes and that the success of the scheme is based on ‘member inertia’ – in other words it relies on people being too lazy to opt out. However, when they reach retirement they are then presented with a plethora of retirement income choices which they are then expected to navigate on their own – and the success of which is ‘predicated on the ability of members to make informed decisions’.
‘If a large group of people cannot understand the risks they face, they should not be expected to manage these themselves,’ said Blake in the report.
‘Instead, if there are well designed and regulated schemes which use retirement income products that manage these risks in the most efficient and cost-effective way, it might be possible to nudge or default savers towards one of these schemes.’
'Safe harbour' needed
The report recommended the development of ‘safe harbour products’ that would provide access to pension funds, inflation protection ‘either directly or through investment performance’, and ‘longevity insurance’ to ensure the money lasts.
It said that currently no product is offering this mix for retirees and that individual products may not be the answer but instead a ‘large-scale decumulation scheme’ may be the answer - an idea which has been floated by the National Employment Savings Trust.
‘[Large-scale decumulaion schemes] have the potential to be much cheaper and deliver more consistent results than conventional individual drawdown and annuity products, due to: economies of scale, trustee oversight, the use of a well-designed institutionally-managed fund, and the potential for the bulk purchase of members’ annuities,’ said the report.
In particular ‘middle Britain’ with pension pots of between £30,000 and £100,000 should be encouraged to ‘use a retirement income plan that involves a simple decision tree with a limited set of pathways’, including annuities, drawdown and longevity insurance.
These pathways would point the member towards the best products for their needs, with the aim being a ‘simple solution’ that is ‘good enough’ for those who do not want the responsibility of making financial decisions themselves.
Jim Boyd of insurer Partnership said leaving retirees to fend for themselves in retirement ‘may place an unreasonable burden’ on them as ‘one wrong choice can have severe consequences – and mean that an individual may run out of money before they die – or unnecessarily live in poverty’.
‘A set of safe harbour products would see more people achieving desirable outcomes,’ he said.
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