George Osborne’s budget contained some radical pension reforms, but for the broader investment ecosystem there is less than meets the eyeby Nick Carn / March 20, 2014 / Leave a comment
Osborne’s Budget is aimed at capturing the valuable pensioner vote
There’s no doubt that the Chancellor’s reform of pensions announced in yesterday’s budget are radical ones, not only from a practical but also from an ideological point of view. Clearly something had to be done. As interest rates have tumbled, so annuity rates have converged on a rate equivalent to a staged return of the pensioner’s capital—minus, of course, the high costs and charges typical of retail financial products. Since only certain sorts of institutions are able to offer annuities a regulated oligopoly has been more or less able to dictate its own terms.
Government mandated monopolies, limited competition and restricted choice usually add up to a bad deal for the consumer and the annuity market has proved no exception. Allowing all pensioners the range of options which were only previously available to those with either very big or very small pension pots breaks the stranglehold of the annuity providers.
It also breaks with the long-standing presumption that people’s personal financial affairs are too important an issue to be left up to them. The requirement to take pension benefits in the form of an annuity has been in place since well before World War Two. It had been successfully argued that otherwise retirees would be inclined to blow their savings on high living and then throw themselves on the mercy of the welfare system. Indeed, this is one of the criticisms that has already been leveled at the Chancellor’s changes. Doubtless some would choose a brief interlude of abandonment and a lifetime of penury, but the arguments by the pension industry had a large self-serving element.
For a long time, the life assurance industry advanced a similar argument maintaining that only tax relief and large opaque sales incentives would persuade people to save. The extremely poor returns achieved by “with profits” life assurance policies, notwithstanding the friendly investment environment of the last 30 years, are sorry and eloquent witnesses to its powers of persuasion
The full details of the pension changes are yet to be decided but individuals will still be allowed to take up to a 25 per cent tax-free lump sum, and then be allowed to withdraw up to 100 per cent of the balance paying only marginal tax. At the moment those with small pension pots of less than £18,000 are able to withdraw the full sum. Those with large pots (over £310,000) have a range of options including income draw down while those in the middle, the vast majority, have restricted options. Under the new rules everyone can stake a 25 per cent lump sum and then choose between annuities, full withdrawal or income draw down.
For the broader pension and investment ecosystem there is somewhat less to this than meets the eye. The reason is that the largest existing pool of assets is in the defined benefit sector. Pension funds are one of the biggest buyers of long duration fixed income assets (including government bonds) and a move away from annuities would reduce demand for this type of investment. Although in theory members of defined benefit plans can withdraw their entitlement as a lump sum and make other arrangements in practice this happens relatively infrequently. Moreover, tucked away at the back of the HMRC document are proposed restrictions (including compulsory annuitisation) on switching assets from defined benefit plans to the newly attractive defined contribution plans. The new freedoms do not, it appears, extend to the £1,143bn of defined benefits (DB) assets.